- The Jumping Cholla
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- Betting the Over / Under
Good Morning!
This is the Jumping Cholla (CHOY-uh). The newsletter that turns options market insights into a fun, easy-to-read email that helps you reduce your chances of getting pricked while trading!
And even if you don't trade, learning how to think like a trader builds a robust framework for problem solving, taking risks, managing a plan, and just living life.
Quote of the day:
"Different strokes for different folks"
- Sly and the Family Stone
The legendary R&B/Soul group Sly and the Family Stone said it best! Some people like betting the over, and some people like betting the under. It's all groovy, jive ass turkey!
Let's take a break from dealer hedging implications and think about the fundamentals of what you're betting on when you buy an option vs. sell an option.
BANG for Your Buck:
| 1/25/2023 SPX = 4016.95 | Handles of Movement | Implied % Move |
|---|---|---|
| BANG (intraday) | 49 | 1.2% |
| BANG (weekly) | 108 | 2.7% |
Position Note:
Dealers are net long the 4000 strike. Pops above will be sold and smaller breaks below will be bought due to hedging. This level is like a little magnet. Even yesterday, the market closed a touch lower and volatility was down. Without a material change in the risk-on/risk-off environment (maybe some crazy earnings reports), there isn't much for people to do. The market seems to be waiting for Feb 1st FOMC.
Dealers are net short the 3900 strike. A break below opens the door for expanded volatility and easier extension of a selloff. Recap of short option hedging from yesterday.
Betting the Over vs. the Under
Since many of you are avid sports betters, I want to relate buying vs. selling an option to betting the over vs. betting the under.
Ignore call vs put, because we want to focus on the fundamental differences between long and short options.
Buying an option = betting the over
Selling an option = betting the under
Betting the over or under in sports betting is a way to wager on the total number of points, runs, or goals that will be scored in a game.
If you bet the "over", you're wagering that the total score will be more than the set "over/under" line (think about this as the strike price). For example, if the over/under line for a football game is set at 45.5 points, and you bet the over, you're betting that the total score of the game will be 46 or more points. (your long option ends up in-the-money)
On the other hand, if you bet the "under", you're wagering that the total score will be less than the set over/under line. In the same example, if you bet the under, you're betting that the total score of the game will be 45 points or less. (the option will end out-of-the-money)
You bet the over when your expectation for scoring is higher than the bookie's.
In options trading, you are getting long volatility. I.e. you think that expected price movement implied via option pricing (BANG) will increase ergo you buy volatility!
You bet the under when your expectation for scoring is lower than the bookie's.
In options, you are shorting volatility. You think that the BANG is too high compared to your expectations!
Over/Under Pyschology
Betting the under: The game starts at 0-0, so you are winning the bet the entire game (until you're not!)
Betting the over: From the onset, you are losing the bet and hoping and praying for some action!
These psychological differences require completely different management approaches.
Long volatility requires active management.
Any outsized move must be capitalized on. As volatility increases, the range of possibilities expand. Your long option makes money, but also there is now a greater chance that your option can end up out of the money as well! (remember, volatility doesn't tell us direction)
You cannot "just set it and forget it", because if you do, you won't make as much. Well in reality, you will just lose. There will be countless times of "It was in my favor, and I thought it would keep going." If you don't want to manage it, you are using the wrong tool for the job...you should just be trading the underlying.
Short volatility requires limited management (and balls of steel).
Less management, 90% of sold options expire worthless, and just don't react too much...sign me up! Well, the cost of minimal management is major management at the worst possible time all while you are losing bigly!
It's like using your Showtime Cooker. You "set it and forget it", leave the house to run some errands...
...you get home to find that chicken grease caught fire and it's starting to burn down your house!
Are you the type of person who can handle putting out the fire?!
You have to figure out what you personally can handle. You don't have to be good at both either. Different strokes for different folks.