Is options trading gambling?
The recent global market crisis caused a lot of options traders to lose
their fortune. Increasingly, there are people who are referring to options
trading or derivatives trading at large as gambling. This is probably due to
the many options traders who had their positions go down to zero, taking their
whole account with them.
Did the stock investors do any better?
Many pensions and individuals had big positions on GM before the 2008 crisis
begun and fully intend to hold it as “investment” rather than speculation. But
look at where GM is now… barely a dollar. Didn’t those “investors” lose their
shirt as well? Shouldn’t stock trading or investing in stocks be gambling as
well?
So what is gambling?
In essence, putting money into something hoping that it will do well when
you can do nothing about how the price movement of that thing moves is
gambling. Depending on an uncertain future outcome in order to make a profit or
loss is gambling! That includes stock “investment”, options trading, futures
trading, warrants etc. How different are those from horse betters who “analyze”
the performance of horses and then place their bets waiting for an outcome?
Accepting the fact that betting on an uncertain future outcome with money
on the line is GAMBLING is the beginning of trading and investing.
How did high stake professional poker players make a profession and a
living out of a “Gambling” game? The real secret is risk management. Risk
management is what takes options trading out of the realm of gambling into the
realm of investing.
The beauty of options trading is that risk can be hedged and position can
be sized to any risk management needs. To take the simplest example, don’t buy
more call options or put options than the amount of money you are willing to
lose! See? Options traders who cannot accept the fact that trying to predict
future outcome is gambling, who like to think in terms of “sure win”, will put
all their money into a single position and lose their shirt. And then cry about
options trading being gambling. Yes, options trading IS gambling in the sense
that future outcome cannot be predicted! It is proper risk management that
takes options trading out of the realm of gambling and into the realm of
investing and trading.
In fact, with proper risk management, options trading can be much less of
a gamble than buying stocks itself!
This is because you can structure options strategies that profit in more
than just one direction whereas if you buy stocks, you only make money when the
stock goes up! With the possibility of profiting in more than one direction,
chances of winning is greatly enhanced, risk lowers and the trade becomes more
of an investment than a gamble! See?
For example, a Call Ratio
Spread allows me to profit when the stock goes down, stay stagnant or up to
a pre-determined price! In all 3 directions! Now, how is that gambling now that
the exact future outcome is no longer that important to profitability? With a
Call Ratio Spread, I won’t have to be exactly correct on where the stock is
going, because it is unpredictable in the first place, and still make money!
See?
Also, due to leverage granted by call and put options, I could control
the profit on more stocks using lesser money! By using only money I am willing
to lose in one trade, I could reduce risk and yet control the profit on stocks
which will take a lot more money to control!
Now, options trading is not magic. Options trading can be risky without a
comprehensive understanding of how it works and how each options strategies
work but once you reach that level of competence, options trading becomes more
trading and investing than gambling with the proper risk management strategies
in place. The point I am trying to get across to you in this article is this:
Anything that depends on an uncertain future outcome is gambling and that
includes options trading and stock investing. However, with proper risk
management and hedging strategies, options trading can become a lot less
dependent on the accuracy of the future outcome than stock investing, thereby
becoming more of an investment than gamble.
