Last updated on September 4th, 2022 at 12:02 am
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The popularity of options trading has soared in recent years, due to the increase of people looking for stay at home type jobs and people wanting to work for themselves. The cryptocurrency boom of the last couple of years has also fueled options trading to new heights as people try to replicate the successes they hear about.
However, many analysts who are against this method of trading call it gambling. So what’s the truth?
Options are not gambling for savvy traders. In gambling, players mostly rely on luck as the house always has the edge. In options trading, experienced traders only risk money if they know the asset well enough and have a clear reason (often backed by statistics) for going with a direction.
Beginners who trade directional options (buying calls or puts) will often be just gambling with their money though if they don’t have a plan for what happens if the trade goes wrong (and they often will).
Options in and of themselves aren’t gambling as they allow you to leverage your money to achieve quick gains if the stock goes in the direction you think it should. However if the stock goes in the opposite direction and you have no plan or if you are just buying options based on a rumor you hear online… you’re pretty much just gambling.
In the rest of the article I will go into a bit more detail on why options are not gambling when used properly.
When Options Are Not Gambling
As I mentioned above, how you are using options really determines whether they are gambling or not.
Options are not gambling in the following scenarios:
You Have a Strategy With a High Success Rate
The best options traders have clear-cut strategies honed from years of experience. Most of these strategies may include elements such as:
- Cash secured puts
- Covered calls
- Stock replacement
Regardless of the approach used, having a clear-cut plan removes the guesswork in trading. You already have an idea of what type of options to trade at any point, with clear entry and exit rules.
Also, you know why you’re favoring long or short for any position.
With a working strategy, you likely understand the theta and delta of an option. You’ll also choose the strike price based on your comfort level and risk tolerance, and you’ll model the profit or loss in complex trades.
A working strategy gives you an edge in the market. Some traders have strategies that end in profits up to 95% of the time. Even at 60–75% success rates, that’s a higher chance of success than is achievable in any casino game.
You Don’t Trade Weekly Options
Weekly options offer extremely short-term exposure. Unless you’re privy to important information about the underlying asset, it’s infinitely harder to predict such short-term movements.
Remember, weekly options only have about 4 trading days to develop so it’s much more like gambling.
There’s a high chance that the price won’t move fast enough to reach your strike price or go beyond it. One scenario where weekly options might make sense is if you’re investing in an asset tied to a pharmacy company announcing drug trial results within the week or a tech company with income reports scheduled.
Many people get sucked into weekly options because of the near-instant gratification and lower prices. Still, it’s almost impossible to have even an average win rate here.
You Know the Stock Very Well
Savvy options traders only go with stocks they know well enough. You can’t know everything, but analyzing a company’s balance sheets, dividend records, ownership distribution, financial reports, past market performance, and the overall market trends can put you in a good position to make informed trades on the stock.
There are also tons of statistics out there for you to look at. You can’t get such a trove of data in any casino for any games.
Having so much information to guide your decisions tips the scales in your favor.
You Avoid Volatile or Hard-To-Value Stocks
Avoiding options in volatile stocks or those that are hard to value is a good way to significantly increase your odds of winning.
For example volatile stocks like Alibaba (NYSE: BABA) or Tesla (TSLA) move so erratically that it’s almost impossible to make money with them consistently. In the last one month alone, Alibaba’s stock has fallen by more than 16%.
Any call options on it are probably already out of the money—including those with a 3–6 months expiry.
Tesla stock is slightly erratic, but it can sometimes jump 5–6% in a week. In the options trading world, that’s a lot of movement.
When stocks are hard to value, you can cover your bases with the data and technical analysis, but it only takes one event to send them spiraling downwards or rocketing upwards.
Sticking with calmer stocks like Procter & Gamble, Berkshire Hathaway, Apple, etc., is always a safer option.
When Options Are Like Gambling
Options become more like gambling when you do the opposite of everything I have mentioned above, such as:
- Jumping into positions off recommendations from social media
- Not having a properly documented strategy and clear guidelines on entries and exits
- Buying options in popular but volatile assets
- Not having any real reasons for favoring any one direction
If you trade options in this manner, you’re no different from gamblers in a casino. You probably shouldn’t classify yourself as an options trader at this point.
Why Options Trading Is So Hard
Trading options is so hard because you typically have to get the timing AND direction right for any position you take. Getting the direction right is already a challenge; working on the timing makes it even more daunting.
It may take months for a stock to reflect the real underlying value. Your options will most likely expire before then.
It’s for this reason that many experts warn investors against options. There’s a lot of work involved to make sure you’re not just basically making trading decisions off a coin toss, and not many people have the discipline and skill for that type of work.
The average investor will be better off buying stocks in stable companies and waiting for compounded gains.
Still, it’s not easy to ignore the earnings potential with options.
How To Excel in Options Trading
To excel in options trading, you should devote more time towards developing a clear-cut strategy (or learning one from experienced traders) and then committing the time and energy required to practice the strategy for at least 6 months.
Many options brokers offer a demo account. Take advantage of these to hone your trading skills for as long as necessary. This will improve your odds of success.
However, you should avoid making options trading the bulk of your investment strategy. Ideally, you should limit your exposure to 10% of your capital and 10% of your time in the market.
Trading options is not gambling for savvy, well-experienced traders with a working strategy and the discipline to stick to it.
It’s gambling for inexperienced and poorly educated wannabe options traders who haven’t taken the time to learn a strategy but continue to trade in a scatter-gun manner.