Why I will not be a buyer in Options during earning seasons

Whenever I see people buy lottery tickets in anticipation of making quick bucks or realizing there dream of becoming millionaire on the back of my mind I get the image of an Option traders who buys in anticipation of making his trading capital increase by several folds.. While a few bucks lottery  ticket doesn’t seem to be a lot of money to spend to win millions, the odds of you winning are slim to none due to the millions of different combinations of all the total possible numbers. We will be starting with earning season soon and many high flying names such as Infosys, Reliance,SBI  just to name a few, traders may be tempted to make their next option trade similar to buying a lotto ticket with the hopes of winning big.To add to fact every month there are traders who buy Calls and Puts thinking about a black swan event to occur and turning there few thousands into millions again odds of you winning are slim or next to NIL.

In my opinion, an options lotto ticket is where an individual makes an out of the money call or put purchase based on an event that can drive up shares of the underlining stock higher or lower. These events usually include earnings, conference calls and media related events. The lottery part of the equation usually stems from a trader making a directional bet, with the anticipation that the news goes their way. If the news doesn’t go their way, the contract will most likely expire worthless and one will most likely have little premium left since option traders are limited by the amount of time till expiration.

When one plays their state’s lottery, tickets that are bought are also defined by time. In options, trading  calls or puts for a particular expiry leading up to a big event, Most of Traders understand Options as Limited Risk game as risk involved is capital you have speculated but THINK if you looses the bet your whole capital will vanish and by any business sense it does not make a good trade. There is nothing wrong with making speculative out of the money call or put bets in the option market, but investors/traders should avoid making casino style bets, unless they have the discretionary income to do so.

There are certain group of people who always have sources of discretionary income with them and even if they lose the bet it does not affect their financial health and do not get themselves KICK out of market due to the blowout trade. These people just try their luck and it’s a pure entertainment from them. BUT EVERYONE IS NOT SO LUCKY and this is what a trader should understand before placing a casino style bet.

Options are hopeless for poor people who use them as substitutes for stocks

because they can’t afford the real thing. Professionals take full advantage of starry-eyed beginners crowding into options. Their bid-ask spreads are terrible. If an option is bid Rs 3, offered at a Rs3.25 , you are 25% behind the game as soon as you buy. The expression “your loss is limited to what you paid for an option” means you can lose 100%! What’s so great about losing everything?

If you are a newer investor to the game of options, I would recommend avoiding the allure of cheap out of the money calls or puts and I would only recommend non-directional option strategies (strangle, straddle and reverse iron condor for example) for trading around a stock event. Here are some reasons I avoid trading out of the money calls based on an event:

1) Time: The closer to expiration, the greater the probability that the out of the money call or put will expire worthless. If you have the discretionary income and don’t care about a loss, at least give yourself a time horizon that has a greater probability of getting to your destined target . Also, the closer you get to expiration with out the money options and your target is not reached, the greater you will have little option premium left. Therefore, you will join the ranks of the thousands of option contracts that expire worthless every month. The short amount of time investors have with out of the money calls or puts will increase the probability of time decay. Always rememberwith a short time frame, and if the stock moves up or down slowly, time decay will eat your premium away very quickly.If you would have observed during Last Week of Expiry OTM options decline by 10-15% on daily basis without much movement in Stock/Index.

2) Define Your Risk: Cheap out of the money options are cheap for a reason. Sometimes it can be tempting to purchase large amounts of out of the money contracts, but just because you are purchasing more doesn’t mean you’re going to make more.

3) Speculation: Remember that out of the money is a speculative trade since the odds of you succeeding are further away from happening than an in the money contract or deep in the money contract. In making a speculative bet, you should prepare yourself for losses and have an exit plan. There is nothing wrong with speculating, but give yourself time, the best odds possible and money set aside for speculative purposes, rather than making bets as if you were at a casino.

4) Greeks: Option traders should always be familiar with the Greeks and how they affect option contracts. If you still feel tempted to buy your options lottery ticket, then keeping a close eye on implied volatility, theta and delta can help investors realize how much they could possibly gain or lose.

Sometimes earnings can present frustration when investors are making a directional bet since the event could go positive, but since the stock didn’t reach its destination, investors’ bets will erode very quickly due to little time left.

Generally, I’d rather be a buyer of options when implied volatility is low and play the run-up in the stock and then exit out of the trade before earnings. If one is a buyer when implied volatility is high, investors will be paying a higher price per contract. In my opinion, if you’re going to speculate at least be smart about it and remember that the price of an option contract is important, but is only one factor out of the many to consider when using options.