INVESTING OR GAMBLING

 

 

 

Photography by Dennis Phan  潘家墉

 

 

 

 

Most people I talk to think stock trading is gambling and for that reason, they distance themselves from it. Objectively speaking, it is a good concept. When we gamble, we have little or no control over the game and the House always has an edge in term of winning probability. However, it puzzles me when I see the same people saying stock trading is gambling but they show up frequently in casino playing Black Jack or feeding the “Tiger Machine” quarters after quarters.

 

I made my first stock trade in 1995 and knew little about the market. I simply wanted to get my feet wet and to feel the excitement of stock trading. My main strategy was “buy and hold” Later on, it became “buy, hold and hope” and then eventually “buy, hold, hope and pray” I might not realize it but I was gambling back then. I had 50/50 chance of winning and had little or no control over the game.

 

Visualize ourselves on a Black Jack table in a casino. We have a 21 hand and find out the House has a Black Jack hand. Can we say to the House please let us keep our bet and our 21 hand, the House then gives up its Black Jack hand and let’s play another game so we will have a better chance of winning? I am sure they will look at us like we are aliens from another planet who don’t know how to play Black Jack on Planet Earth. Believe it or not, we can do that in option trading to buy more time and postpone our loss until the market condition works in our favor. Sound impossible? Let’s look at one trade I actually made.

 

To avoid misunderstand of recommending stock, I use ABC as the stock symbol in this trade.

 

·        March 20, 2014: ABC stock was trading above $25/share. I sold April 24.50 short put for $0.60/share.

·        April 3, 2014: ABC stock was trading barely above $24/share. My April 24.50 short put position was in-the-money and it was a losing trade at that moment. To avoid loss, I rolled my April 24.50 short put to May 24.00 short put for a net credit of $0.14/share. I basically tell the market I have a losing position but I don’t want to pay for it now. Give me another chance for my losing position to bounce  back. Though it does not always happen but in this case, I collected an extra $0.14/share for “postponing my debt payment” and getting better terms for my “debt”.

·        The rolling gave me more time for my short put position to work. Best of all, I collected an extra $0.14/share credit and created $0.50 extra cushion in the rolling process. With my original April 24.50 short put trade, ABC stock has to close above $24.50 for my trade to be profitable. After the adjustments, ABC stock only needs to close above $24.00 for me to collect my profit. For those who follow my option lessons posted on our school website, this rolling should be easy to understand.

·        May 5, 2014: ABC stock was up and traded above $24/share. I bought back my May 24 short put for $0.33/share, closing my position altogether  and recognizing a net profit of $0.41/share. 

 

Let’s take a closer look at the trade:

 

·        My original selling of April 24.50 short put on March 20 gives me roughly 9% per month Return On Capital (ROC) if the stock closed above $24.50/share on April 19, 2014. Please notice the ROC percentage varies with different stocks. For this particular stock, it yields 9% ROC. That was my plan A. However, if adjustments are needed and the trade drags on for, let say, 3 months, I still make roughly 3% per month ROC, not bad for plan B. Good luck doing that with the bank Certified Deposit Account. I have control over my ROC.

·        I closed the trade on May 5, 2014 for a net profit of $0.41/share, a roughly 6.7% ROC in 45 days from March 20 to May 5, not bad for a trade that didn’t even go as planned on the first try. Good luck doing that on Black Jack table. I  have control over the length of my trade. 

·        I pick ABC stock which is an Exchanged Traded Fund (ETF) to avoid earning surprise quarterly and to make my rolling easier if needed. I have control over avoiding earning cycle altogether.

·        I pick ABC stock since it is very liquid with $0.50 strike price increments and penny wide bid and ask option price which is an ideal scenario for option trader. I have control over the stock liquidity.

 

Apparently, I have full control over my trade. With that control, I make the Probability of Profit (POP) works in my favor.

 

I frequently went to Las Vegas for my investment conferences and seminars during my stock and option learning process. I never stopped by casino to play Black Jack during those visits. Knowing I am playing a game I have full control and an edge of POP, why bother playing Black Jack, a game I have little or no control and the House has an edge?

 

Investing or gambling? you decide!

 

 

 

Dennis Phan   潘家墉

1971/1974 Khai Minh Doan Ket Class

06 May 2014 in Claremont, California, USA

 

 

 

 

 

 

 

 

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