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- How Options Trading Works
How Options Trading Works
Becomes the casino, not the gambler.
997 Words | 4 Min 9 Sec Read
Welcome to another issue of Passionate Income.
Today we’ll be discussing how options trading works.
Similar to day trading and crypto, options trading involves making short-term investments that when done right, can pay a profit. At the same time, this high risk, high reward form of investing has some unique nuances that make it very attractive if you can wrap your head around the numbers.
Let’s dive in.
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If you know anything about Vegas, odds are you’ve heard the saying:
“The house always wins.”
Now, we know this is not 100% accurate. If there was a literal 0% chance of ever winning, no one would gamble.
In fact, people win all the time.
But when we look at it from a macro level, there’s a reason casinos turn a profit: Because over the long-term, most people lose.
So why do I bring this up?
Because investing in options is similar to the casino's business model. Except instead of you being the gambler, you’re the house.
And as we know: The house always wins.
With that said, I do not mean to imply investing into options is some kind of safe or guaranteed bet. In fact, relative to passive investing, options are very high risk / high reward.
So while gambling odds favor the house, making casinos guaranteed winners, there are no “guaranteed” strategies in the world of stocks and investing.
With that said, selling options is the equivalent of taking the casino’s side of the bet. In particular, you can take a conservative position that minimizes your risk, while at the same time profiting off the greed of high risk gamblers.
So how do you become the house?
If you're at all familiar with the markets, you know Investing 101 says you buy stocks when they're low and make a profit by selling them when they're high.
Or if you're more advanced, you might short the stock and hope the price goes down (which is a reverse approach to buying low and selling high, except you start with selling instead of buying).
What you might not realize is that there are strategies that can generate a profit whether a stock goes up, down, or stays the same.
In particular, advanced strategies that involve selling someone else the ability to take ownership of your stocks if the price rises to a specific level within a defined time frame.
I know this can sound intimidating, so let’s use a simple analogy.
Imagine you own a 1oz bar of gold. And the price of gold today is $1,000 per ounce. Now imagine your neighbor thinks the price of gold is going to go up to $1,200 by November 31st.
Instead of buying gold for himself and waiting, your neighbor makes you an offer. In particular, he says:
“Hey Tom, how about I give you $50 today and if the price of gold hits $1,200 or higher by November 31st, you let me buy that gold off you for $1,050 per ounce.”
In this situation, you generate immediate income (the $50) by selling your neighbor the ability to buy the gold you already have at a future point in time.
Further, if the price of gold does in fact go to $1,200, you also make a profit.
How?
Because $1,050 is $50 / 5% more than the $1,000 per ounce it was valued at when you made the deal with your neighbor.
Even better, even if the price of gold drops to $950, you’re STILL breakeven.
Mainly because you got the $50 in immediate income from selling your neighbor the right to buy your gold at $1,200 (despite taking a $50 loss on the price drop from $1,000 to $950).
And this is how you become the Casino instead of the Gambler.
See, you stand to make a profit whether the price of gold goes up, stays the same, or falls less than 5%.*
*If it falls below $950 you would in fact lose money, which is why this strategy is not "guaranteed" / still involves risk.
On the flip side, your neighbor is making a high risk bet. In particular, he’s spending money to bet on a hypothetical future (gold hitting $1,200 by Nov. 31st) that may or may not happen.
Admittedly, this shit is complicated and requires a serious math brain.
Unlike stock trading, options trading requires a full-time focus and is much more niche than day trading or even crypto.
With that said, there are men and women (OK it's 99% men) who earn a full-time living trading options while working just a couple hours per day.
So if you like the idea of trading, but think crypto is a little sketch or too high risk, you may want to go down the options trading rabbit hole.
💡 Takeaway: Unlike stock trading, where you only generate income if you sell a stock after it's gone up in price, selling options allows you to generate income by selling someone else the ability to buy or sell your shares in the future.
And while trading options is high risk and requires a serious math brain, it's also a much more legitimate market and career path relative to crypto.
🎁 Resources:
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