Ask HN: Is option trading as bad as gambling?

I guess many people here would have expected the Boeing stock to drop in value after the news emerged that a second one of their brand new plane models fell out of the sky.

Would it have been an irresponsible financial decision to buy Put options on the day of the second crash with an expiry of 3 months hoping that at some point in the next 3 months the stock would drop a little to sell with a profit?

I would say yes as well. Especially if are not an expert and have really solid reasoning for the "bets" you are making!

A very recent example of things not happening the way I expected them: the Dow Jones plummeted about 1,000 points last week due in large part to the effect, or perceived effect, of coronavirus on the markets. No shocker that it went down. But then just yesterday there was a huge rally because the Fed reduced interest rates. That’s the unexpected part for me. Maybe others saw that coming but I would’ve lost my pants on that gamble.

Comments about events "priced in" are absolutely right. With a little work, you can make it transparent and use it to your advantage.

In simple terms, the price of an option at a given time is equal to the product of what you can expect to gain from it (its payout) and the likelihood of each payout (the implied distribution of the asset at maturity). The interesting consequence is that you can reverse-engineer option quotes to derive the "market-implied probability distribution of a given asset at expiry". You can then compare this to your expectations to enter positions (for example if you think the market overpriced/underpriced a given event, trade against it with options).

You first need to calculate the implied volatility of options quotes (both calls/puts on both bid/ask) which requires you to correctly adjust your forward, i.e divs and rates to obtain put-call parity. If your forward is wrong, your implied volatility curves will look off (for example put bids above call asks) which means you have the wrong rates or dividends expectations. Once you computed the implied volatilities and are happy with your forward, you can fit a curve between your 4 series (call ask, call bid, put ask, put bit). This is your implied volatility mark. You can then use this volatility mark to derive an implied probability density. There is a simple example of how this is done here:

https://www.mathworks.com/company/newsletters/articles/estim...

This is actually really useful when you are trying to manage your risk for a given event. It also has interesting dynamics. Back in 2014 for example, we were worried about our risk on PBR US (a massive petro company with strong political links) ahead of Brazilian elections. By using this method, we found out that the implied distribution of the stock was bimodal, each mode corresponding to one outcome of the election. This gave us an idea of how much the stock could move either way and helped us cover the risk.

If you would like to see whether a given event is indeed priced in as you would expect, you can use this method, bearing in mind there is a timing element and you should seek the option expiry just after the event or horizon you are considering.

One last point that is important to consider is that this is “market-implied distribution” and does not imply a future behavior for the asset in question. It merely gives you an idea of the expectations of actors at this moment. Moreover, it is highly dependent on your inputs (dividends, rates and how you fit your volatility curve between bid/ask options quotes, particularly on the wings).

Former options trader here. The reason its called stupid flow is that 99.999% of retail traders use them wrongly and don't understand them. That said, you can educate yourself and use options properly. But don't let any broker or retail educator "educate" you, they don't want you good and have huge conflicts of interests. Get education from technical articles and by learning the underlying maths and pricing dynamics, particularly the relationships between implied volatility smile and price distribution.

One of the main reasons they are dumbly traded by retail has to do with the ban of CFDs in the US. As retail investors want leverage (attracted by a quick buck rather than making money on the long term), options provide an alternative, and retail brokers push them to customers.

But there is a massively misunderstood dynamic: time. You don't only have to be right. You have to be right by a certain time. Another misunderstood dynamic is risk management. Options are useful as part of a portfolio, but if you use them only as a means to get more leverage on your directional portfolio, you will end up like all traders losing money that don't understand why. Yet the reason is simple: you took too much risk.