Maybe options would be priced that way if the market was only made up of us retail investors.
But standard options models (which would be used by dealers and institutional and other professional traders) don’t value/price options as described above.
In fact, in standard models the option price doesn’t depend on the expected direction of the stock price.
Instead, the key market inputs are an interest rate and the stock’s volatility (standard deviation of stock price fluctuations).
(other inputs are expiry date, strike price, and current stock price - but nothing about the expected direction of the stock price)
That options can be priced without the expected stock price return was a major breakthrough and the ideas in the Black-Scholes-Merton model for options prices resulted in a Nobel prize in economics.
The price doesn’t depend on the direction of the stock, but that’s because options traders can (and often do) perfectly hedge the option with changing amounts of holdings of the underlying security. But that’s not what captaincc is doing. He’s not engaged in dynamic hedging - he’s just selling covered calls. So he’s not making a volatility bet or making a market in options and earning money on the spread - he’s making a directional bet on the underlying securities. His actual counterparties are likely doing the same - the market makers and institutional liquidity providers are hedging nearly 100% to stay delta neutral, which means that all of captaincc’s directional bet is being absorbed by an almost-certainly retail investor counterparty.
Maybe I misunderstand what you mean, in a couple places.
For one, upthread you wrote:
To me the above means that the option price (premium) in the market depends on the direction of the stock, as you write: “what the market thinks are the chances of the stock going above … “
But now you write:
Seems like two opposite statements, to me.
Are you saying the market option price typically depends on the expected directional movements of the underlying or no?
I misspoke in my earlier statement. Perils of casual message board writing. The price depends on the volatility of the underlying, not the broad direction of its price movement. They’re not entirely unrelated - if XYZ is currently at $10.00 and the strike is at $11.00, a highly volatile stock is more likely to exceed $11.00 at some point than a low-volatility stock. That was what I was thinking of upthread, but certainly not what I wrote.
I guess you have not been reading my posts. I have not invoked magic. I have stated the mechanism by which covered calls make money and that includes picking the right stocks.
Stocks that don’t go broke
Volatile stocks that bounce back
Stocks whose call options produce the highest returns
Where, when, or why did I post about magic? Does Merlin work for you?
What I have been thinking about lately is never selling, just follow the stock’s volatility up and down. The recent downdraft was an important lesson in this regard,
Be slow in rolling down - protect capital
When rolling up & out - minimize premium loss
If the stock skyrockets - consider letting the calls expire
All this is based on covered calls, the risk profile of naked calls is waaay too high. Above all, protect capital.
…which made me think that you believed that there was something particular about selling covered calls that was different than other investing strategies. But it’s not. Selling covered calls isn’t like running a casino, where there are asymmetric advantages baked into the system that favor the house more than the players. Casinos are profitable because of those advantages . The house always wins because the gambling is structured in a way that favors the house.
Covered calls aren’t like that. There’s no structural advantage favoring the call writer over anyone else in the market. You’re just placing bets inside the casino like everyone else, not running the casino and benefiting from some systemic advantage.
But, perhaps I misunderstood your point. Jet lag is a cruel mistress…
You still don’t understand. Anyone else in the market is not involved, only call buyers (gamblers) and call sellers (the house). The odds are rigged in favor of the call sellers and against the call buyers. For option trading anyone else in the stock market is irrelevant.
I’ve been meaning to write a post considering stocks not as an investment but as the asset needed by a casino selling covered calls. You keep anchoring in the past, I’m trying to document a new way of making money not in the stock market but in the options market. My contention is that the covered call market is less risky than the stock market and will display a more even Pareto distribution.
They’re not. The odds aren’t rigged in favor of the call sellers against the call buyers. Call sellers are not the house. They’re players in the casino.
As a call seller, you’re making a bet on the future price of a stock. The call buyer is making a different bet. Neither has an inherent structural advantage.
I have to quibble on this point in favor of the good captain. Sellers have the structural advantage of time decay.
Buyers win (very) big when they win but they win less frequently than sellers (who I think win about 60% of the time).
I think of the person that called my Tesla stock last year probably risked a few grand, maybe $5k, but likely made $60k over that few weeks period assuming they did an exercise and sell.
Again, selling covered calls is a relatively straightforward wager. You’re exchanging the potential upside on your equity position above the strike price in exchange for a fixed payment, while retaining unlimited downside exposure. You get some extra income through the premiums, but you lose a non-trivial portion of the gains of being invested in equities.
This isn’t “traditional stock market lore” - it’s just the nature of the wager you’re making. You’re not the first person to discover buy-write strategies. This isn’t some “new way of making money” that you’re pioneering. There are plenty of buy-write funds and ETF’s you can invest in, if you want. These generally have tended to underperform the market in bull markets (because the money you gain from lots of small premiums hasn’t been enough to overcome the lost opportunities from foregoing the huge big wins), while they will outperform the market in flat or down times. In a world where the bulk of market returns consist largely of a few massive winners with outsized gains (which is the recent market), a buy-write strategy like this will seriously underperform the market.
There’s no structural advantage to call sellers vs. call buyers. It’s a bet on whether the market is going to be bullish or flat/neutral (or the securities in the specific portfolio).
You are conflating the stock market and the option market. They are different markets.
GoogleAI:
The stock market and option market are entirely separate financial arenas with different pricing, risk dynamics, and structural functions.
Review the fundamental distinctions that separate these two markets:
Asset Nature: Stocks provide direct, fractional ownership in a company. Options are derivatives; they are simply contracts granting the right to buy or sell underlying shares at a set price.
Expiration Lifespan: Stocks can be held indefinitely. Options contracts are strictly time-bound and carry fixed expiration dates, after which they expire worthless if not used.
Pricing Mechanics: Stocks derive their value primarily from fundamental metrics like company earnings and market supply and demand. Option valuation relies on external factors including the stock’s strike price, time to expiration, and implied volatility.
I’m not conflating them. I understand that stock markets and derivatives markets are separate markets.
Playing in the derivatives markets doesn’t make you “the house.” You don’t have any structural advantages over your counterparty, and it doesn’t mean you’re going to gain any long-term advantages.
Again, selling covered calls isn’t some new innovation in financial technology. There have been funds doing this for decades now. They underperform in bull markets, and outperform in flat or down markets:
…and because they underperform in the bull markets by more than they overperform in flat or down markets, a buy-write strategy will generally trail the market over the long term.
Now, there’s certainly a beneficial trade-off there: you get some modest reduction in risk/variance in exchange for that reduced return. But there’s also nothing extraordinary about that - you can achieve the same result by mixing in other asset classes (like bonds) in your overall portfolio as well, if you want to trade down risk for a reduced return.
But selling covered calls doesn’t make you the house, and it doesn’t give you some structural advantage over the other players in the casino.
But it’s not a useful metaphor, because it’s not at all true. Or alternatively, you’re not using the metaphor correctly. If you’re using a casino metaphor, the person selling the covered calls is another player in the casino. They’re not the house. The bets aren’t stacked in their favor. There’s no structural advantage making their position more beneficial than their counterparty’s.
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