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Is it possible to get rich on the stock market with options trading?

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  • Is it possible to get rich on the stock market with options trading?

    Just curious

  • #2
    Yes, of course it is possible. It is also possible to lose all your money. You already know it can be very risky. Here is a better form of the key question: On average, how well can you expect to do in options trading?

    Even though the stock market is unpredictable, it turns out that it is possible to build mathematical models that can answer this question. In fact, the simplest mathematical models are based on the assumption that the stock market is unpredictable, at least in the short term.

    Comparison with Stocks – Short-Term

    For short-term options trading, the answer is the same as for short-term trading of stocks, see: James Baker's answer to If I were to invest $1000 into a stock and stock flip that, how much money will I make averagely speaking? In the short-term: The average return is to lose your commission and half of the bid-ask difference.

    Comparison with Stocks – Long--Term

    Perhaps surprisingly, for the longer term the answer is different for options than for stocks. For stocks, the average return for a given time frame is the market average minus the average half-transaction cost. Options are much more flexible.

    For any particular parametric probabilistic mathematical model, with options it is possible on average to beat the market!

    Thus, returning to your original question: Yes, you can get rich trading options. Short term you can get rich, just as you can in any other form of gambling. If in “trading” you include longer time periods, you can even use strategies that on average will do much better than the market averages.

    TANSTAAFL (“There ain’t no such thing as a free lunch” The Moon is a Harsh Mistress by Robert A. Heinlein)

    You don’t get these market-beating results for free. There is always some trade-off involved. With options investments that are designed to beat the market on average, typically the trade-off is the worsening of some loss event that has a low probability. That is, there is some loss out in the tail of the probability distribution for which the particular option strategy either increases the amount of loss or the severity of the loss. This trade-off can succeed in increasing the average return if the probability and severity of the loss are low enough that increasing them doesn’t affect the average very much. You are making your worse-case scenario worse in order to improve your average.

    Can You Learn to Do This?

    Yes, you can learn to do this form of analysis. It won’t be easy. I don’t know any textbook that teaches this method of analysis or any on-line advisory service that uses it. If you have a friend who is a Wall Street Quant, they probably don’t use it. They probably will tell you that what I am saying is nonsense because it is not what they learned in school and also not what they use in practice. The mathematics is actually similar to and simpler than the mathematics they use in Black-Scholes analysis and in improvements on Black-Scholes, but it is used in a different way from a different point of view.

    I can teach the core principles for computing these averages to someone with the required mathematical background in less than 5 minutes, in fact, I have. Teaching an adequate but simplified version of them to someone who does not have the background would require something more like a semester course.

    You Need to Know More About Risk

    However, you need to know more than the core principles. You already know that options trading can be risky. Although some options strategies can be designed to reduce risk, these market-beating strategies actually increase certain kinds of risk, typically the risk in at least one of the tails.

    If options are viewed as part of a larger portfolio, there are portfolio-level strategies to mitigate these risks. However, these strategies require balancing multiple objectives simultaneously. To do that properly, requires assessing the individual investor’s risk tolerance and avoidance profiles for several particular kinds of risks and rewards. In other words, the portfolio-level strategy must be customized to the particular portfolio and to the particular individual.

    This may be one of the reasons that this form of analysis is not taught in textbooks or used in on-line analysis. Managing the associated risk cannot be handled with one-size-fits-all advice. In addition to its complexity, that is also one of the reasons I won’t try to explain it in detail here.

    I also won’t try to give investment advice based on this analysis. I am still trying to figure out how best to balance these risk-reward trade-offs for myself. Unless your risk tolerances and preferences happen to be identical to mine, I have no idea what the correct investments would be in your case.

    I will tell you the particular kinds of models that I use for my own analysis: I model the stock market as a hidden stochastic process. However, I don't think that the form of the model in important. I think many other forms of Bayesian of semi-Bayesian analysis would work as well. You don't really need anything more than elementary probability theory, although you need to apply it in a sophisticated way.

    However, returning again to your question as we have now modified it: “Yes, if we can model your risk preferences, we can design a customized mathematical model by which you can on average beat the market averages.”

    Yes, you can get rich using such a model.

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    • #3
      Definitely possible but you should never try to get rich from scratch on wall street. Wall street works better when you already have money from another source and use that money to further your net worth.

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      • #4
        Originally posted by RIPunclePhil View Post
        Definitely possible but you should never try to get rich from scratch on wall street. Wall street works better when you already have money from another source and use that money to further your net worth.
        Agreed. Making a living should be your first priority when trading anything. Not just options.

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        • #5
          Certainly. People consider that options trading is very risky. This isn’t the case, once you know what you are doing.

          There are numerous books and online resources which you can use to learn about the various strategies. Once you understand the risk-reward characteristics of each strategy, it’s up to you to determine which strategies are best for you. For example, I subscribe to an options trading service, whereby the fellow who offers the service proposes an “options trade of the week”. I don’t get into each of the proposed positions, because some of them offer downside potentials (which the service provider explains to his subscribers) that I’m not willing to accept. Know thyself!

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