Every March since I was a kid, I enthusiastically filled out a
NCAA Tournament bracket. Way before the Internet, I would submit
my picks to the local newspaper with the hope of getting my
picture in the paper. I was eight.
It was easy…I picked a few of my favorite teams from my
most-beloved conference at the time and allowed the chips to fall
where they may. There was no process behind my selections. Other
than the obvious mismatches, I simply guessed. While this
simplistic strategy occasionally works for gamblers (and eight
year-olds) it's not the tactical approach most savvy bracketeers
Serious bracketeers gather as many statistics as they can to
make the most informed decision possible. Factoids such as the 12
seed has beaten the 5
seed 24 out of the last 27 years or two teams seeded 10 or lower
have gone to the Sweet Sixteen 14 out of the last 16 years can
only increase the probability of accurately predicting a
Unfortunately (or fortunately, for those of us in know), most
approach their picks with a gambler's mentality…randomly placing
a bet and hoping for the best.
And the ignorance of the gambler carries over into the
investment arena, particularly in the world of options.
In the spirit of March Madness I hope to teach you, the
self-directed investor, how to approach the market with a
statistical advantage using options. Options make intuitive sense
if they can be viewed in an easily understood framework, such as
There is no denying that options can befuddle even the most
Professionals and retail investors alike struggle to
understand the core fundamentals of options and it shows in the
ongoing ignorance of how most investors choose to use them.
Take for instance the most basic and frequently observed
characteristic of an option - delta. Delta is the probability of
an option finishing in-the-money. In basketball terms, it's the
probability that one of the teams will win.
For example, let's take my beloved Oregon Ducks.
On the surface the 12
-seeded Ducks look like underdogs versus the 5
-seeded Oklahoma State Cowboys. However, the professional odds
makers have a different prediction…they view the game as a
toss-up, a coin flip. Before the game begins Thursday, each
team has an equal chance of winning or, as I like to say,
With options, 50% is a typical delta for an at-the-money
option (i.e., the underlying asset's price is equal to the
option's strike price) with a relatively short term to options
expiration... let's say one expiration cycle, or roughly one
In basketball terms, the tip-off hasn't occurred. The Ducks
and Cowboys are tied. Each team is neither ahead nor behind, just
like the option isn't in or out-of-the-money.
Now suppose the Ducks are heavily favored. They might have a
delta of, say, 80%. And since the game has yet to begin they
would be considered in-the-money. Vice versa, if the Ducks
were the underdogs they would have a delta less than 50%, say
20%. An option with a delta of 20% would have a very difficult
time closing in-the-money or above 50% by the time it reached
So, if we can predict a winner with 80% accuracy, why do we
insist on guessing, thereby decreasing our odds to a lowly
coin-flip? Again, gamblers and investors insist on taking this
approach even though we have resources that enable us to increase
our odds significantly.
If you are interested in how I make trades with an 80% chance
of success don't miss Sunday's edition of
The Strike Price
I will be discussing, in great length, my favorite way to
trade options. It's an extremely simple strategy to learn and
arguably the most powerful strategy in the professional options
traders' tool belt.
Editor and Chief Options Strategist
The Strike Price