The Paradox of Options Trading
Imagine you're faced with two choices:
1. Guaranteed one year's worth of salary.
2. A 50% chance of getting two months' salary or a 50% chance of getting five years' salary.
Which would you choose?
This question often confronts options traders. Due to the non-linear, exponential nature of options, such choices can easily arise, particularly in one-sided trending markets.
In trading, two key factors stand out mathematically: win rate and payoff ratio. However, the presence of time decay in options makes it challenging for buyers. Unless it's an exceptionally strong one-sided market, buyers often find themselves at a higher probability of losing, relying on hitting it big once to offset multiple losses.
But as one delves deeper, one encounters a psychological barrier: loss aversion. Faced with the aforementioned choice, it's easy to opt for the first, safer option rather than the second.
The non-linear, exponential nature of options inevitably triggers emotional fluctuations and amplifies loss aversion tendencies.
If you choose the first option, the advantage of high payoff in options significantly diminishes. Slowly, the focus shifts from high payoff to high win rate.
Win rate in options: Extending the expiry date increases the probability. A 5% rise within a day, a week, three months, or six months holds vastly different probabilities. In a bull market or a logically strong market, longer expiry dates yield higher win rates.
Payoff ratio in options: The more speculative and nearer the expiry, the higher the leverage. However, this also intensifies time decay, significantly lowering trading win rates.
Optimal outcomes in many events follow a reversed-U-shaped distribution. It's not about the higher the leverage, or the farther the expiry, but rather a blend of leverage and win rate.
This is a rational mathematical outcome. However, during actual trading, another crucial factor comes into play: the holding experience.
A positive holding experience fosters adherence to theoretically sound trading plans. For instance, steady small gains each day, akin to bank interest or bond holdings, can sustain long-term commitment.
Conversely, day trading, scalping, or 0DTE, with their constant need for screen monitoring and emotional roller coasters, can lead to quick burnouts during adverse conditions.
This, too, is deeply ingrained in human nature. Happiness often arises from numerous small victories, emphasizing frequency over magnitude.
However, a scenario where one loses $300 daily, for 300 days, continuously, only to make $218,700 on the final day, yields the same result. But it breeds doubt, irritability, and the likelihood of quitting in the following year.
Thus, emphasizing win rate over payoff ratio can significantly enhance the holding experience, making it easier to stay committed. However, from a mathematical perspective, prioritizing payoff ratio over win rate might yield better financial gains.
Because in life, wealth accumulation often requires one significant event (favoring magnitude), whereas happiness stems from countless small victories. Perhaps, this is the paradox of options trading: the most profitable and the most satisfying holding experiences aren't always the same.
However, one crucial aspect must never be forgotten: compound interest thrives on minimal drawdowns and numerous small gains.
Disclaimer: Community is offered by Moomoo Technologies Inc. and is for educational purposes only.
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Some famous words of Buffett. I hope it's useful to you. : )
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unfilteredtruths : Guaranteed one year's worth of salary. I'm risk adverse.
But also it depends. If you have a lot of cash sitting around, bet on the second option.
TSLA2800 unfilteredtruths:
72926798 : Well when you buy those puts the price will rise until you sell off for a loss, then the second you do the price drops, basically says fk you