Patrick, I have to defend the out of the money options theory. I am glad you mentioned horse racing, because my betting style there is very similar to my options buying style.
Of course I would rather buy an in the money or at the money option than an out of the money option if my returns were similar to out of the moneys. Just as I would rather bet an overwhelming favorite at the track to show instead of a 15-1 longshot to win if I got as much money back when I won. But it doesn't work that way. still, the key factor is cost (risk) and reward when you are right. When you make 2 points on an in the money option, that is nice. But when you lose, you are likely to lose 4 to 5 points. With an out of the money option that costs you 1/2 or 1 point, you are likely to lose more often, but when you win, you make multiples of your bet.
The trick, no matter what your style of investing or betting, in options or at the race track, is to bet on overlays. If a horse is 2 to 1, but his speed and form and breeding indicate he should be even money, then 2 to 1 is an overlay. If a horse is 20 to 1, but should be 30 to one, that is not an overlay just because the odds are high. I have a friend who does nothing but look at the odds board and then she hits me on the arm, "Mike, Mike, number 8 is 90 to one."
She gets very excited. She doesn't care that it has 3 legs. <G>
With stocks, if you have one selling at, say, 31 1/4, yet it has a reasonable valuation at $6, and the credit quality of a $3 stock, then you want to swing for homeruns on it. If you have a Coke that is selling for probably double reasonable value, you may want to figure those far out of the money puts are not as much of an overlay and stick to less risky ways of playing it.
So, when you are dealing with total crap like Micron, and my favorite put stocks are when I can find total crap that is overpriced for some bizarre reason (insanity in the investment community, too many technical analysts, more money than brains <G>), an out of the money strategy is likely to have the best expected return. When I buy puts on a good co., like Electronic Arts, which I think is overpriced but not likely to go to zero, I play a bit closer to strike.
BTW, the opposite is true with option sales. I want to sell the at the money options to suckers because they have the most pure dream content. There is a rule to options spread trading that goes, "buy intrinsic value, sell fluff." That has been a profitable rule
for me for years.
When it comes right down to it, being right on the stock is much more important than which options you buy or sell. But I think risking little to make a lot, even if it is more improbable, has better odds in the long run. Since most gamblers and investors avoid the less probably returns, they pay off more than they should in an efficient market or race course.
Good luck, MB |
