MI Rewind: Should YOU Trade Options? with Tom Sosnoff

24:25So you take the least amount of risk in a longer period of time and the most risk in the shorter period of time. And that's how options basically break down. So yeah, the answer to your question is yes. Is it also a proponent of taking money off the table? Because if you've made a trade and you've made, I don't know, say you've collected 80 % of the premium in the first, would you say 45 to 21, so 24 days, then maybe you could catch another 20 % of the premium, but maybe you've already collected 80%. You just take that off the table before you lose that? You are correct. And it's not 80%. If you can get to a 50 % number, then you take it.

24:57So the answer is like, you like to sell puts. Let's say you sell a put for a dollar. If you can get to 50 % or 50 cents in the first 24 days, you take it. That's mathematically optimal. We own Tasty Trade, which is the largest digital network now in the world for finance. And then Tasty Trade owns Tasty Works and a couple of other companies too. We own a digital asset company. We own a magazine. We own another brokerage firm called Doe that competes with the free ones. We have an advisory. We have lots of different companies. But our primary business, or my primary job, is to provide financial content.

25:32And in that, it's all free. And our archives have literally thousands or tens of thousands of hours of mathematical concepts, we don't do any fundamental or technical analysis. We are anti-fundamental, anti-technical analysis. All we do is math and quantitative analysis. Is this research statistically significant, and does it meet the math test? And if that is the case, then we put it out there. We're a think tank. That's something that I'm going to have to take from this episode and implement in my portfolio because for the most part, I've let them just go to expiration. And typically, it hasn't really bitten me yet.

26:10There was one time where it did, I think I had already gotten maybe 90 % to 95 % of the premium, but I was waiting for that last 5 % to 10%. And then it went against me and I ended up having to buy the underlying shares. But I think this is going to be a good implementation for my strategy. Robert Leonard We have great research on this, Robert. It's awesome. And you can see all the numbers will play it out for you. It's amazing. You take, just to give you a ballpark, you take almost 300 % more risk in those last three weeks than you take in the first three and a half weeks. And so when you sell, you just buy the next one that's 45 days out.

26:48What if you're doing it at 30 days? Do you not recommend buying at 30 days? That's fine because you can't always do 45 days. You just do closest to. Still, it stays at the 21 days? Absolutely. The technology today is so good and it's so cheap. Trading is basically free. I mean, it's just a hair over free. You can't afford free. If you're trading, anybody listening to you, you're trading on a free app, that's a mistake because they're not good enough. You need better technology. You need really intelligent technology. Like we say, you can't afford free. You need something that's beautifully designed, intelligent technology that can apply strategic logic to it.

27:25In those examples, man, it's so good. You can roll stuff forward. You can do it all as a single click. You can take your front month position, roll to another back month. You can buy in your front month. You can diagonalize it and go to the back month. You can do anything you want nowadays. You can change your quantities. You can do it all as a single click. Piece of cake. Other than Tasty Trade, which I would recommend people go to, other than that one, what are some other platforms that do well? The best platform in the industry for the last decade or so has been a platform called Thinkorswim.

27:55I built that. And our team at Tasty built Thinkorswim. We were floor traders. We left the floor in 1999 and 2000. We built Thinkorswim from scratch, and we became a public company. We were bought out in 2009 by TD Ameritrade, and we left in 2011 to start TastyTrade. And then in 2017, we launched TastyWorks with the same team that basically built Thinkorswim back in 2000. So we built a better mousetrap is essentially what it is. So now we have the fastest growing brokerage platform in America behind Robinhood, but we're a very different type of platform. We're an intense piece of software. Robert Leonard When it comes to, we talked about selling on the upside of puts, if it's going the way that you want it to, but what if it goes against you?

28:45Does research show that there's a point where you should say, this trade has gone against me, it's not coming back, I should just cut my losses? Robert Leonard When you sell something, let's say, we'll go back to your example originally. Let's say you sell a put and you sell with an 80 % probability of success. So that means you're selling a 20 delta put. Our research suggests that if that put goes to, let's say, 40 deltas, it doubles in delta. So you have a losing trade on right now, that at that point, you should do something. So there's a couple of choices of what you can do. The first thing you can do is because you're short of put, you can sell a call against for no additional capital.

29:19You're already short of put. So you can turn around and sell an out of the money call. Let's say you're short of 40 delta put in the example you just, I took your example of originally selling a 20 delta put, it becomes a 40 delta put. Now you're down money. So what can you do? For no additional capital, you could sell a 20 delta call and reduce the risk in your position theoretically by half. That's one thing. Or you can buy back your 40 delta put and move it out a month. So in other words, let's say right now you're trading January. You can move it out to February, and then you can move your 40 delta to 30 delta for a small credit.

29:53That's your second choice. Third choice would be to reduce your size. And then the fourth choice, obviously, is you can cover the position or buy another option against it. But that would be our last choice. Robert Leonard Is there one of those three things that's most optimal? Robert Leonard Optimal is selling the call. Robert Leonard And how does that work tactically? Could you give us an example? It could be a fake stock, but give us some numbers of a stock. Robert Leonard So take a stock like XYZ, and let's say you sold a put for$1, okay? Just like you said. Now, all of a sudden, the stock started to go down, so you're wrong.

30:26And the put that you sold for$1 is$2. So now you're short a$2 put, and now you're nervous because the velocity of risk is always to the downside in stocks. So now you're saying, well, I got to do something here. It's totally reasonable. So you look at the calls and you go, well, I'm going to sell a$1 call. that$1 call is going to offset half the risk of that$2 put, at least theoretically. You put up no additional capital to do that. That is the first thing you do. The second thing you do is if you don't want to sell the call, because that makes you nervous about getting whipsawed or something, you buy back that$2 put in the front month and you sell a$2 or$2.50 put the next month out, but that'll be a lower strike put.

31:11So you're actually reducing your risk because you're giving the trade more time. That's how options work. You pay for time. And that would be the second thing. And then the third thing is you can either buy another put further out of the money or reduce the size of your position or close it altogether. How do you go about calculating your returns on this selling a naked put strategy? Do you divide the premium that you've received by the amount of money that you had at risk? Or do you just look at how much premium you collect throughout the year. And if you're asking, how do we figure out return on capital?

31:42We don't look at trades on a return on capital basis because we think it's really misleading. In other words, you can create, you can kind of cherry pick return on capital without getting into too much of like, too granular on this. You can make return on capital look whatever you want it to look like. But if you were doing it in the purest sense, you'd say, oh, I sold this put for a dollar and I put up$500 to do it. So my return on capital for one month is 20%. I mean, that's the most simplistic way to do it. And that's fair.

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35:03You can get started by creating an account for free. Who knows, maybe TIP Finance will help you find your next 100-to-1 investment. Between the screener and Legend Investment portfolios to reference, I've gotten a ton of ideas from TIP Finance. What are you waiting for? Take the next step in your investment journey today with the right tools at your fingertips. Grab your device and type into your browser theinvestorspodcast.com slash TIP-finance to get started. That's theinvestorspodcast.com slash TIP-finance. All right, back to the show. So that's exactly how I've typically gone about it. But then I was thinking the other day, as I was preparing to chat with you.

35:45And I'm like, if the trade's successful, we get all that money back, say we get that$500 back. Now our cost basis is essentially zero, right? And we made return without any money at risk. So now what is our return? It's infinite, right? Yeah. It's basically basis reduction is what you're talking about. The original concept behind options, when retail customers got into option trading originally, it was really all about improving your basis. So for example, you buy a stock and then you sell a call against it that's out of the money. And then essentially what you're doing is instead of buying the stock at$100, you're buying the stock at$98 if the call expires worthless.

36:19It's all about improving basis. If you want to get short a stock, you sell an out of the money put against it, and you improve the amount. Instead of selling it for 100, you're selling it for 102. So effectively what you're doing is you're improving basis. The whole business of options was about improving basis for one person. One set of people, it was about speculative leverage. The other set of people, it was about improving basis. those opportunities and risks still stand true today. Except today, the markets are much more strategic. So there's even more things you can do, which didn't exist in prior decades.

36:49Robert Leonard We've talked a lot about the benefits and the upsides of options, but what are some of the risks and downfalls that options provide? Robert Leonard A lot of people trade too big. So one of the things with options, we have a philosophy at the firm, which is trade small, trade often. Because trade small keeps your risk in check and often gives you law of large numbers. The mistake that virtually everyone makes that gets them in trouble is size. There is no issue in the whole world of finance other than size. Because if you believe like we believe, I don't know what you believe, but if you believe like I believe that markets are random, ultimately markets are random, that nobody knows what's going to happen next.

37:34And I've been around the block enough times to know nobody knows what's going to happen next. And given that, the only thing that can get you in trouble and the only way that you can manage risk is based on the size of your positions. Ultimately, you can do certain things that are very mechanical, like you can sell the right Delta, you can sell the right number of days, you can buy the right Delta, you can buy the right number of days, you can do all the things. When you get in your car somewhere and you're going somewhere, you can't control what other people are going to do, but you can control your own risk.

38:04You can wear your seatbelt, You cannot drink. You cannot be on the phone. You can go the speed limit. Those are the things you can control. In trading, it's exactly the same way and options even more so. Take care of the things you can control. Opening the trade at where you want to do it, using the right strategy, being diversified among strategy and underlyings, having the right number of mechanical days, having the right price objective, choosing the right delta, all that kind of stuff. You can't control what the stock's ultimately going to do. So just have the right size on. Stay small. Robert Leonard For anyone who has studied Warren Buffett, they likely know that he's actually quite an options trader or just an options investor, if you will.

38:41For those who haven't studied him, they probably wouldn't know that because it's not really publicized. Why don't you think Warren Buffett's option strategies is widely covered in the financial news? Robert Leonard I think it has been. Warren Buffett's been a little on both sides of the fence on this. I mean, one of the famous Warren Buffett quotes are, derivatives are basically weapons of mass destruction. That's one of his famous mass financial destruction. The other side to it, he's probably made billions of dollars selling option premium. When you're long a lot of stock, you can sell a lot of premium.

39:16Or when you want to get long a lot of stock, it's mathematically most strategically viable way to get long theoretical stock. People that don't understand options and derivatives don't understand that they're the exact same thing as buying or selling stock. The theoretical equivalent is perfect. You can buy 100 shares of stock or sell two, let's just make it simple. You can buy 100 shares of stock or you can buy two 50 Delta calls. Theoretically, it's the exact same thing at the exact same time. There's no difference. You can buy 500 shares of stock in the SPDRs, for example, the S &P 500 ETF, which is the most actively traded product.

39:57You can buy 500 shares of spiders, you can buy one S &P e-mini future, or you can do 10 at the money spider options, and they're all the exact same thing. And people think, oh my God, that's so much different. They're not. They're all the same thing. Theoretically speaking, they're exactly the same at that moment. No difference. What would lead somebody to one strategy over the other? Either a lack of know-how or capital efficiency. Robert Leonard And so is Buffett selling out of the money calls essentially on stock that he owns a lot of, basically? So if he owns, say, 100 shares, but say he owns more, say a million shares, would he sell an out of the money call?

40:37And if the stock goes up to that price, he has to sell? Robert Leonard Generally speaking, I think given the size and the scale that he has of his underlyings, I don't think he sells a lot of calls against his position. I think Warren Buffett, from what I've read over the years, he's much more of a put seller and an index put seller. So he'll sell, let's say, a billion dollars worth of S &P puts after a huge down move, that kind of thing, and then hope they expire worthless a year from now. I don't think he's a very sophisticated option trader. I don't think he has to be. When you have 50 or$100 billion, I don't think we're going to judge him on his skill level of if he understands gamma risk or whatever else it is.

41:20But I think he's been ridiculously successful because something that he doesn't have to deal with that you have to deal with is the emotion of potentially pain. Whereas a small investor has to worry about their portfolio size and their net liquidating value. And somebody like him, you can take a billion-dollar shot and you're going to be fine. Robert Leonard What do you think about those long-dated, say, put strategies? We were talking about selling puts earlier. We're talking about selling them at 45 days. What if we sell them a year out? two years out, three years out. It's not an interesting strategy to me because it's not something that's necessarily...

41:57I mean, there have been different points in history after huge down moves and volatility explosions where I think it's interesting maybe to consider it. But generally speaking, long-term options for me are just not... It's like trading a stock. It's not that interesting. Is it just because it's not active enough? That's right. And you're limited what you can do with it and you're stuck in that position forever. One of the things I love about what I do is every month, I get a clean slate. Every year, I get to start over. Every month, I get a clean slate. It's really cool. I like the fact that I get to essentially start over all the time.

42:34When I think about these long-dated put strategies, I have a hard time imagining that, say, I don't know, just say a company Visa, right? Say we sell it$50 under where the strike price is$50 under where the share is today. I I have a hard time believing that Visa is not going to be higher than that price in two years. I just find, even if we have a recession, I have a hard time that markets typically go up into the right. So I find it hard to think that just macro thinking, we're not getting into the nitty gritty of options. You're a millennial. You are right and smack dead center. My son's just a year or two older than you.

43:06He thinks the exact same way you guys can be twins. Earlier this year in March, you got your first whiff of a bear market, but it didn't last very long. And you have never seen anything that is prolonged for longer than... I mean, you saw this March when the pandemic news broke, you saw a 35-day bear market of 30%. Imagine that market went down. So let's say you did Visa at$250. The stock's trading$250. I don't know where Visa is. Let me just see where Visa is. I don't trade it that often. 214, I think-ish. Yeah, 214. So let's say you sold the 150 puts. Let's say I went out to January of next year, January of 22, 381 days away.

43:48And I went down and sold the 150 puts. They're$5.50. So they're pretty far out of the money. They have a delta of 12. That means statistically, there's about a 10 % chance that it gets under 150. This is right in your wheelhouse. You collect five bucks for making that trade. Now, remember that even though there's only a 12 % or a 10 % chance of getting down to that 150 level, if we went into a prolonged bear market over the next, let's say, year or so, the idea that Visa couldn't go to$50, I mean, it easily could. And the amount of capital that trade is going to tie up, it could easily go under 100.

44:24And for that stock to be cut in half, you remember in the financial crisis of 2008, now you were only 13. But in the financial crisis of 2008, stocks like Visa went down to single digits, single digits. So we're not talking about like $100, we're talking about like under 10. And I don't remember exactly how low Visa got during that whole move, whatever it was. But we're talking most of the stocks got under 20 or$25 and the financial stocks got under 10 and Visa is a financial stock. So I'm just guessing it was under 10 bucks. So when you look at that, and the stock was probably 150 at the time, You're not thinking it's going to lose 90 % of its value, but it could happen.

45:02And again, I understand how positive drift works. And I understand how markets work over time, but it's not a guarantee. So is that a strategy that's better used if we had already seen a sell-off than you implemented then? I think so. If you've already seen a sell-off, then look at Visa for a second. I mean, yeah, it's a strategy that... Where do you think Visa got to in March? Just in March. Robert Leonard I bought a lot of Visa in March. Robert Leonard So I think my cost basis, I think, was around 140-ish. Robert Leonard You bought almost the low, like 135 was the low in March. And we barely went down.

45:41We only went down 30%. If this market had sold off 50%, that stock would have been about 80 or 90 bucks. And if you had sold the 150 puts, you would have been nervous as hell. But the fact, the only way to protect yourself and something like that, if you wanted to go out and sell a put in Visa two years from now, I would sell it into a down move when it's scariest time. And I would also say super small. I would not do it at all time highs. Visa's two ticks off all time highs. And when you say small, one, two contracts? Well, it depends on the size of your account. For millennial, one, two contracts, right?

46:13And if you're Warren Buffett, 10 ,000, 20 ,000 contracts, whatever it is. When we think about selling calls on the upside, a lot of people argue that that's not necessarily a great strategy because of this drift that you mentioned. Stocks typically go up and you're limiting your upside. What do you think about that strategy? Robert Leonard I think it's absolutely fine. And especially 12 years into a bull market, I think it's better than fine. I mean, the hard part about selling calls is it has, over the last two decades, it's been less effective than selling puts. But I think over the next two decades, it's actually going to be a more effective strategy.

46:51Because I don't think you're going to see the same upside velocity that you saw for the last 12 years. So I like the idea of selling calls for the next decade. Robert Leonard As we round off the show, what's the best piece of advice that you can give to the listeners of the show? It could be about options trading, entrepreneurship, investing, or maybe even just life in general. What advice has really impacted you throughout your career? It's pretty simple, I think. For me, I mean, I shouldn't speak for anybody else. I tell this to my own kids, and I tell this to everybody that I talk to lots of students, millennials, and whether they're employees or anybody, friends, doesn't matter.

47:30It's really weird. But one day you're 25, like you are today, and you're going to close your eyes. And the next thing you know, you're 50. And you're going to wake up and you're going to go, where the F did my life go? And you're literally going to wake up and you're 50. I still think I'm 25 and I'm 63. You do close your eyes one day and you wake up and it's 25 years later. So my advice to everybody listening is every opportunity in your life that you have to take measurable or calculated risk, go for it. Don't ever hold back, not even once. Don't sit back and think about it. And I'm not talking about doubling down on 11 when you're in Vegas with everything you have.

48:13Not that kind of... That's not the life advice I'm talking about. But every chance you have to do something where it's kind of a risky decision, but if it works out, the payout is going to be greater than the risk, you should take it. We call that kind of pot odds. And every opportunity you have to take risk, every decision that you get to make, like people say to us all the time, well, we built$2 billion companies in the last 20 years. That's pretty cool. and every opportunity we've had to take risk over the last 40 years, we've done it, every single one. And I would say that the reason we've been successful is because we are not afraid to make a decision and take risk.

48:55And that's even at this age. At 22 or 23 or 25 or 27 or 30, take every bit of risk you can because otherwise you'll regret it forever. That's really timely advice and actually good confirmation for me. And I'll tell you a quick story because I raced motocross growing up. That was my background. And then I stopped when I was 14. I didn't race for 10 years. And then when I was 24, I got back on a bike again. I was mostly just doing it for fun. And before I was on track to go pro, I had some big contracts when I was 14. A couple of things happened. I didn't end up going pro. So when I got back into it when I was 24, I decided I wanted to just do it for fun.

49:31It's my biggest passion in the world. And then I started to think there's this race in Tennessee. It's the largest amateur motocross national in the world. And there's a bunch of qualifying events that you have to do to get to it. And I said to myself, I said, if I don't try to make it to qualify for that event, I'm going to regret it. I said, I'm going to wake up, like you said, when I'm 50 and I'm going to regret this. So I went out, I bought a dirt bike, I started training again, and this summer I'm going for it. It's one of my biggest things. And it's just so timely to what you just said. Yeah.

50:02I'm telling you, and this goes with life and business, personal stuff, just everything. I'm not talking about taking stupid risk either. I'm just talking about if it's calculated, whatever it is, and even if you, assuming, I mean, hopefully you qualify, you win, whatever it is, but even if you don't, you're not going to regret it. I mean, it's going to make you think differently about every other decision you get to make. There's a lot of schools of thought about things like the power of decision-making and the power of taking risk. And for people that make a their chances of being successful are almost a thousand times greater than people that don't.

50:43And you have to respect that that is a very... When we hire people to work for us, we want people that can make decisions. That's the most important thing to us. Can you make a decision? Answer a question fast. I don't care if you're wrong, just make the decision. Robert Leonard Tom, thank you so much for joining me today. It's been a true honor and it's an interview that I've looked forward to for quite a while now. Where can everyone listening go to learn more about you and all the different things you're working on? If you want to watch me, if you can take any more of me, every day from 7 in the morning until 10 in the morning, we do a show on tastytrade.com.

51:19It's free and it's called Tasty Trade Live, 7 to 10 in the morning, Central Time. Eastern Time, it's 8 to 11, obviously. And then we're back on again in the afternoon for what we call last call from 2.30 to three central time. And then if you want to check out our brokerage firm, it's called Tasty Works. And you can check that out at tastyworks.com. It's the coolest piece of technology out there for trading. It's an amazing platform. And we also own another app called Doe, which is another brokerage firm, Doe.com, D-O-U-G-H. We have a magazine called Luckbox, which is a fun magazine to read and it's free.

51:54You can go to Get Luckbox and it's a digital magazine and it talks about trading and life and everything else. This month's issue is on the art and science of forecasting. And I think that's a good start. We have a great learn center on tastytrade.com. And listen, if you want the coolest technology around and you want to see all the stuff that we do, and you want to do some of the stuff that we talked about today, just check out our stuff. I'll put a link to all those different resources in the show notes below so everybody listening can go check it out. I highly recommend that you do. Tom, thanks so much for your time.

52:26Thanks so much. Thanks, everybody. All right, guys. That's all I had for this week's episode of Millennial Investing. I'll see you again next week.

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