A casino’s edge ranges from 0.5% for blackjack to as high as 17% for some slot machine games. Now, of course, this edge may or may not play out on the first, second, or tenth roll of the dice. But they are not in it for the short-term game. You see, the casino doesn’t have to beat every player every time. They just know that they’ll win their mathematical edge so long as enough bets are placed each year.
It’s precisely why casinos offer huge incentives to get you to come back with free show tickets, free meals or even free hotel rooms. It’s why the force table limits on how much you can bet on each hand and why they give you free drinks for playing. While you might think it’s just them being nice, it’s not. It’s an investment they know pays huge dividends. In fact, on average casinos spend up to $45 each hour to keep you sitting in your seat and betting money.
Now, I frankly don’t care if you like or hate casinos because the reality is that it’s an insanely profitable business model based on simple math and expected outcomes. As options traders, we can learn a lot about how we should run our own trading business from casinos. In today’s show, I want to walk through some of the most important takeaways that you can apply right now to your trading system and invite you to open your mind and try to see the big picture strategy.
Key Points from Today’s Show:
- All businesses have an edge, and it is a game of patience over time.
- When it comes to casinos, over half their rooms are given away for free because they know that the longer you stay, the longer you will play.
- Most casinos will actually give you money to start gambling to get you into your seat and keep you playing.
A Casino’s Edge
- Casinos know and realize that they do not have to beat every player every time.
- However, they also know that it is just a matter of playing their edge over time and over many different players.
- Ex: with roulette, there is a 5.5% edge, 17% edge with slot machines, 0.5% for Blackjack, etc.
- There are all small edges, but yet they know that it will play out in their favor over time.
Trading Options Like a Casino.
- Using their edge, casino’s do not care about one player at a time — they focus on the long-term game.
- This strategy should similarly be applied to options trading. Single losing trades should not make a big impact on your overall trading position and outlook.
- In casinos, there are often table limits set up in a game. They know their edge is long-term so one large bet carries much greater risk than many small bets over time.
- This is similar to an options trading portfolio — keeping a small position, and position sizes.
Understanding the Trading System.
- Between your first trade and your 100th trade, anything can happen.
- You could be profitable 90% of the time or only 40% of the time.
- That does not mean the system is broken or that probabilities and options trading does not work. It just means that you have not played it enough.
- You have to let the numbers work out over time.
The Edge in Options Trading.
- Implied volatility is a great trading vehicle even when it is really low. You can still make money selling options, even when implied volatility is low.
- However, the edge is smaller when implied volatility is low. The amount of money you can generate when implied volatility is low is less than when implied volatility is high.
- Therefore, when implied volatility is low you will do smaller positions and a lower allocation of your portfolio.
Using Your Edge to Your Advantage.
- Casinos deliberately lay out their casinos so that the most amount of opportunities for people to bet are in the games that have the highest edge.
- For casinos, their edge is smallest in Blackjack — 0.5%
- In 2016, 74% of casino revenue came from slot machine, which have an edge of up to 17%.
- In most casinos, their floor space is more than 85% allocated to slot machines because their edge is greatest.
- The same concept should be applied to options trading.
— when the edge is greatest, allocate more to that type of position.
— when the edge is small, allocate less to these positions to create low-level, steady income streams.
The Fallacy of Doubling Down.
- You cannot get the market back. Portfolio drawdowns are part of the options trading game [see episode 75].
- People falsely assume that if you have had 9 losing trades in a row, then the 10th must be a winner.
- However, the first 9 trades have no impact on whether the 10th trade will be a winner or not.
- You have to treat each trade as independently as you possibly can.
You could make 10 trades with 70% chance of success, and 9 of those trades end up being losers. Then you believe that the next trade has to be a winner because the probability of having 10 losers in a row is really high. The problem with this reasoning is that you are not looking at the chances of getting 10 losing trades in a row. You are looking at the chance of the next trade being a winner, or not. The previous 9 trades have already happened and you are basing this investment off of blocks of 10 trades in a row, which is NOT how you trade. This is the fallacy of doubling down. So if you double down on the last trade, there is still a 30% chance that it will also be a loser.
Free Options Trading Courses:
- Options Basics [20 Videos]: Whether you’re a completely new trader or an experienced trader, you’ll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
- Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an “edge” in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
- Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We’ll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
- Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You’ll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
- Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we’ll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
- Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can’t seem to get answered, then this section will help you.
- Portfolio Management [16 Videos]: When I say “portfolio management” some people automatically assume you need a Masters from MIT to understand the concept and strategies – that is NOT the case. And in this module, you’ll see why managing your risk trading options is actually quite simple.
- Trade Adjustments/Hedges [15 Videos]: In this popular module, we’ll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we’ll help you create an alert system to save time and make it more automatic.
- Professional Trading [14 Videos]: Honestly, this module isn’t just for professional traders; it’s for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.
Option Trader Q&A w/ Steve
Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. This week’s question comes from Steve who asks:
How much dry powder should you have in your account to take advantage of rolling or new trades? Is it a percentage of your account size? Does it change based on account size?
Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.
PDF Guides & Checklists:
- The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
- Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
- Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
- Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
- When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we’ll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
- 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.
Real-Money, LIVE Trading:
- EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
- VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
- DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we’ll discuss why I’m adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
- COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
- TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
- MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
- IBB Call Debit Spread (Opening Trade): We’ll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
- TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly – even still the drop in implied volatility helped generate a $330 profit for us.
- XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
- COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
- EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
- IBM Iron Condor (Earnings Trade): Shortly after the market opened you’ll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
- SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.
Thank You for Listening!
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