Options Trading: The Role of Luck

Bad Money Advice is a worthy blog.  Penned by "Francis X. Curmudgeon, the alter ego of a bitterly unemployed hedge fund manager in the suburbs of Boston, Massachusetts," the blog is designed to publicize the fact that so much bad advice is readily available that he feels the need to combat it.  In his words,

"the main topic here is the advice given by others and how bad it is. And
not just any advice. I mean to talk about advice on a single subject of
almost universal interest: money."

In a recent post, he discussed the role that luck has when investing.  Most traders have a great deal of confidence in their ability to outperform the markets, but the unsophisticated retail investor must play the cards dealt. 

"Consider somebody born in 1916 who turned 65 and retired in 1981. In
the 20 years before his retirement the stock market averaged a return of
only 6.57%, just 1.07% ahead of inflation over the same period.
$100,000 invested in the market on his 45th birthday would have been
worth $357,026 at 65.

Now consider someone born 17 years later, in 1933. Over the 20 years
before his retirement in 1998 the market averaged 17.32% a year. (That
happened to be its best 20 year period since 1890.) $100,000 invested on
the last day of 1978 would have grown to $2,440,288.

The difference between $357K and $2.4M is tremendous in terms of
retirement wealth and lifestyle. And yet all that separates these two
people is the year in which they were born. And those years are not even
that far apart. The 20 year investment periods actually overlap."

As traders, we don't rely on the cards dealt to us.  In fact, we are constantly reshuffling the deck.  Nevertheless, any time you deal with probability, statistics must be considered. 

Whether we buy or sell options, we undertake a trade that is based on probability.  Over the longer term, chances are high that statistical predictions will be validated and that a 70% probability event will occur roughly 700 times out of 1,000 events. [Reminder: unlikely events, or the tails of the probability distribution curve, appear far more frequently than predicted].  However, on a single trade, luck plays a role. Or as one definition of the term provided by Wikipedia:
"luck is probability taken personally."

Unless you want to depend on having good luck – a very poor investment strategy – it's important to take matters into your own hands.  That's why it's so smart to practice good money management (size trades properly) and good risk management (control losses). 

As regular readers know, risk management is a constantly recurring theme at Options for Rookies.  Unless you have very good luck, trading without a proper respect for risk, and constantly being aware of and managing risk, there is little chance you can succeed as a trader.  It's a difficult enough profession without taking more risk than is prudent.

Risk management is vital for survival – even when you trade/invest without being a professional.  I wonder if Francis X agrees.  I trust he does.


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5 Responses to Options Trading: The Role of Luck

  1. James 08/13/2010 at 1:40 PM #

    Well said.

  2. Rob 08/15/2010 at 6:27 PM #

    Mark, I have a question. I am kinda confused about the dividends while you sell naked puts or when u sell combos. Who pays the dividends on those imaginary shares. Lets say I sell two naked put for IBM March 2011. Will I owe all the dividends that IBM pays till that expiration day?

  3. Mark Wolfinger 08/16/2010 at 8:00 AM #

    You ONLY owe dividends when you are short the shares of the dividend-paying stock.
    No option position collects dividends.
    No option position requires the payment of dividends.
    Who pays the dividends? The company pays the dividends and anyone who is short shares (not share equivalents) pays dividends.
    If you are assigned an exercise notice on a CALL option, and if that assignment occurs before the stock goes ex-dividend, then you would be short the stock and thus, liable for paying the dividends.

  4. Rob 08/16/2010 at 10:59 AM #

    Thanks mark

  5. build your credit 03/28/2013 at 12:21 PM #

    Nowadays why they are not interest to put money mututal funds. There is no risk our money will be 90% safe. Less services charges and etc..

    Most mutual funds are a big rip-off. It is just stupid (really, there is no other description) to pay a load (commission to a broker) for buying mutual funds. To get the benefits of diversified investing with extremely low fees, buy ETFs (exchange-traded funds) instead.