Selling Options — How To Start Your Own Casino

February 5, 2013

How To

Casino - Sam Rothstein

The casino industry is a multibillion dollar industry. In the United States alone the revenue that was acquired by legal gaming entities was 92 billion in 2007. For an industry where you can strike it rich its pretty apparent that the consistent winner over time is the casino.

Let’s think about where else can you go and get  ”complimentaries”, for free?!

  • Free hotel rooms
  • Free meals (breakfasts, lunches, or dinners)
  • Free tickets to shows
  • Free drinks

But let’s get real Casinos offer comps for basically one reason:

They offer comps to lure you into their casinos because once you are in the door you will gamble and the odds are forever in the favor of the house.

So how can someone like me tap into this lucrative business model.

Easy! Sell options in the stock market.

I’m going to keep this very simple, the concept does not need to be over complicated. As I pointed out in my previous article buying options is for suckers!

Only one outcome is favorable when you buy options

The true value of an option is recognized the day of expiration. The value is determined by whether or not the option is “in the money” or “out of the money” at expiration.  Basically this means:

  • A call option is only profitable if the price of the underlying stock is above the strike price plus the option premium you paid for the option.
  • A put option is only profitable if the price of the underlying stock is below the strike price in addition to the option premium you paid for the option.

Example: For educational purposes these option prices are fictional. Back in November I predicted that the price of Coca Cola (KO) was going up at the time the share price was trading around $36.5 and I was fairly confident that by January’s expiration date the stock would be well over $37/share. I made the decision to buy the January $37 call for $.50/option contract. If you take a look at the chart below you will see that the price of Coca Cola at the January expiration date was $37.05.

Stock chart -- Coca Cola

 

  1. In this example I would have lost money. The true value of the option I purchased was $.05. In order for me to make money the stock had to be trading above $37.50.
  2. Now let’s imagine that the price of Coca Cola was trading for $36.75/share at expiration date. The true value of the option I purchased would have been worthless because the share price was less than the $37 call option I initially reserved the option to exercise.
  3. Let’s take this example one step further. If the share price was $38.25/share at the expiration date, I would have made $.75 per option contract. Remember I was agreeing to pay $37/share for Coca Cola but now it is worth $1.25 more but I must subtract the $.50 I initially paid the seller for the options contract.

So from these 3 examples you can conclude the following:

  • If the price of Coca Cola dropped in value; I lose money
  • If the price of Coca Cola increased slightly;I lose money
  • If the price of the house increased substantially; I make money

That is a potential success rate of 1 out of 3, better known as a 33% chance.  Yes you just read that right, my best odds at turning a profit is 1 out of 3, that’s absolutely horrendous!

Two outcomes are favorable when you sell options

One of the neat things about the options market is there is always a buyer and seller in an option contract. In short, when you buy an option someone has to sell it to you. So based on the example provided above you can conclude that the seller of the option was profitable 2 out of 3 times. That is a 66% success rate, talk about house odds.

With odds like this coupled with a sound financial education you are almost guaranteed to make money in the long run! This week I will show you how I sell options.

Here’s to our Wealth!

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25 Responses to “Selling Options — How To Start Your Own Casino”

  1. My Financial Independence Journey Says:

    I do enjoy selling put options. I sell long-term puts to generate cash. I only sell long-term puts against a solid dividend growth stock that I would have bought anyway. I sell short term puts in place of a limit order. Because getting paid to wait is better than not getting paid. So for me, puts are a win/win scenario.

    I have not ventured into selling calls. I’ve been tempted to sell covered calls before, but I’m not really comfortable with my being forced to sell my stocks when I’d rather be holding them forever.

    Reply

    • Marvin Says:

      I love selling puts as well. As you pointed out as long as you sell them on a stock you already want to own it’s a win/win.

      Covered calls can be a little tricky, but hopefully in the coming week I can show you how to significantly reduce your risk when writing a covered call.

      Reply

  2. AverageJoe Says:

    Excellent kick-off to what sounds like is going to be a great series. I love your casino analogy…I’d never thought of that! I always used a bank analogy: the banker doesn’t make a ton of money on every deal, but good bankers make SOME money on every deal….

    Reply

  3. Dividend Growth Stocks Says:

    Looking forward to reading more about selling options. I’ve considered selling put options but haven’t pulled the trigger yet. One of my issues is I have smaller amount to invest and feel due to option contracts size I usually can’t sell them. For example, using your example if I sell a put for KO at a $36 strike price I need to have (and be willing to invest) $3,600 in Coke shares. For me that would be a large chunk of my current portfolio. Any advice on whether options should be used by investors just starting out without the cash built up yet to use the strategies?

    Reply

    • Marvin Says:

      Depending on your brokerage you can be approved for a level 3 account which will allow you sell puts on Margin. Therefore you will only be required to have 20% of the funds on hand when you sell a put.

      A put for KO at $36 would require that you had $720 in your account. But you are correct if you were to be put the stock you would need to have $3600 on hand. If you are starting out with a small account I would not recommend selling puts because owning the stock would take up a significant size of your portfolio. I never have more than 5% of my portfolio in one position.

      My recommendation would be to continue to save money and buy great businesses at a discount. Overtime your account will build up.

      Reply

  4. Integrator Says:

    I’m looking forward to reading the series. I’ve always looked at selling puts as a way to effectively average in my position in to a stock, and get paid to do so and pick up a higher yield than I would have otherwise done. I haven’t done so to date, but this may be a good time to start. I’d love to get stocks like MCD at a slightly higher yield then where the currently are now, though I understand the premium income on a stock like that is probably lower due to it having lower volatility.

    Reply

    • Marvin Says:

      I sold a put on Mcdonalds earlier this year. I didn’t get assigned the stock but was able to receive a decent size premium. Selling a put is a great way to get into a stock that you wanted to own anyway.

      Reply

  5. Jon @ MoneySmartGuides Says:

    Great analogy. Options can be a complicated thing to fully understand. You did a good job at keeping it simple for all investors to follow.

    Reply

    • Marvin Says:

      Thanks Joe! Glad I could keep it simple. I find that all too often they are over complicated when they don’t have to be.

      Reply

  6. Martin Says:

    Marvin, great review. I had to learn this the hard way. When I started trading options about two and a half years ago I was lured by making tons of money using only few hundreds of dollars. Soon I learned how merciless the time is when against you. A couple of my trades would have been profitable if only the stock moved faster. It moved, but slowly so time decay depleted the profit and at the end I ended with a loss, although the stock moved in my favor! I will never buy an option again, unless really necessary to protect my account.

    Reply

    • Marvin Says:

      I learned the same hard lesson. I would have one winner out of 5 trades, but my analysis would turn out correct out of 4 of them. It was the most frustrating experience ever. I learned that I could not predict exactly when the market would move so I got out of the option buying business.

      Reply

  7. Savvy Scot Says:

    Hey Marvin – What a simple way of explaining a pretty complex subject – good post

    Reply

  8. Steve Says:

    Good lord – a 2 out of 3 chance of “winning”?

    I think it might be worthwhile if you expanded on how much you win when you sell short (and how much you lose when wrong), and how much you win when you go long (and how much you lose when wrong).

    In short, I can tell you with unquestioned certainty that I have done VERY well going long. Very. well. indeed. and my win rate is well over 1 in 3.

    Reply

    • Marvin Says:

      Thanks for dropping by Steve. I believe I explained the options sufficiently enough. Congrats on your win rate that is impressive. However, I said nothing about win rates, I specifically referenced probability and outcomes. The FACT about options is 75% of them expire worthless, therefore I would much rather be a seller of option than a buyer.

      Reply

  9. Aaron Says:

    Do you have any cheaper stocks you recommend for selling puts?

    Reply

    • Marvin Says:

      Hey Aaron, I typically don’t use the share price of a company determine if I sell puts on that particular security. How “cheap” are you looking? I have previous sold puts on IAG – IAMGOLD Corp

      Reply

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