Options Edge: The Definition of Opportunity
On Wall Street, the definition of "Opportunity" can be defined as a situation where your expectations differ from the market's expectations. With Options, you can also call that your Options Edge.
Options are simply a tool that offers leverage. When you buy options you are using that leverage to extract profits from a great Trade Idea in front of you. Choosing the right option starts with Your Expectations built into that Trade Idea.
So, finding an Options Edge requires you to think. Your Expectations need a:
- Target Stock Price.
- Time needed to hit that Target Stock Price.
- Level of Confidence you have in hitting the Target Stock Price within that time.
But remember, Your Expectations are only half of the equation.
In order to figure out if and where there is opportunity on the Options Chain, you need to clearly know the Market's Expectations of a Target Stock Price.
Of course, just by looking at any Options Chain, it's quite evident that the Market’s Expectations hasn’t been given to you. Unless maybe you can see them on the AAPL Options Chain below?
Or on Robinhood’s “half-Chain”? Take a quick look:
Don't worry, you won't find it anywhere. But that cause a slight problem, right?
If you don't know the Market's Expectations embedded in those premiums on the Options Chain, then how could you find opportunity?.
The basic question you have when buying anything hinges on relative value. In other words, you ask yourself whether or not the item is "cheap" or "expensive?" Or which is more valuable?
If you are comparing the same item, then comparing prices can get you the answer.
For example, two dealerships are selling the same car. One dealership has it priced slightly lower than the other. The dealership with the lowest price has the "cheaper" offer.
But what about items that aren't the same. For example:
- Do I want to buy this house or that house?
- This family car or that sports car?
- Or how about this book or that book?
You answer these questions by comparing all the different value points of each. Cheap to you may not be cheap to the next person.
Likewise, all the options you see on the options chain are different. Comparing the premiums won't give you the answer to whether one is "cheaper" than the other.
This is important to understand and is a big mistake made by beginners.
What Should You Compare?
I want to establish the fact that the standard Options Chain does not offer you anything to compare one option versus another option.
The industry does teach a concept called Implied Volatility and uses that to come up with an answer. Unfortunately, that process simply tells us whether an option cost relatively more or less than it did in the past. It does NOT tell us if it is "cheap" or "expensive" looking forward into the future. And it certainly doesn't allow you to compare Your Expectations. That said, it does help Volatility Traders with relative value, but you aren't a Volatility Trader.
This is where all the confusion starts.
You've been given nothing to compare against Your Expectations.
The Options Edge
Let's assume you have view on AAPL stock. You take those expectations to the AAPL Options Chain:
What expectations on AAPL stock price would make that idea an options trade?
And then tell me, which option would you choose?
The Options Industry doesn’t teach you how to get these answers. In fact, they’ve struggled to do so since the Black-Sholes formula was revealed in 1973.
These two basic questions are "the riddle, wrapped in a mystery, inside an enigma." But, as Winston Churchill continued... "perhaps there is a key.”
The key to gaining an Options Edge is with Mathematical Edge.
Mathematical Edge is a 300-year old concept that is used by anyone trying to win a probability game (remember, options is a probability game). And it's not incredibly difficult to understand.
Do you know how to win at "Heads or Tails"?
Good, then you can understand Mathematical Edge.