Ricks Picks

Options Game Thrives on Plentiful Suckers


(Rich Cash, a wise and prolific contributor to the Rick’s Picks forum, as well as a blogger of note, has written insightfully and with good humor on a subject near and dear to our heart – i.e., the put-and-call game. Fortunately, we retired our powder-blue market-maker smock and badge (#K30)  just before the Feds started using RICO laws to prosecute white-collar criminals. We were a scurvy lot, for sure, and Rich has captured the flavor of the game in a way that explains what drew so many of us sleazeballs to the options trading floor. RA)

On Monday, some of the Fast Money Crowd were ready to jump off the bridge after INTC, JPM and GOOG flamed out on brilliant earnings. Tuesday, they were extolling weekly call options on AAPL with 70% volatility premiums. That’s right — if a security that expires in a month is not a risky enough disappearing asset, now we can buy weekly options at a price almost guaranteed to absorb all price fluctuations and expire worthless.

Options have a long and checkered history that dates from the seven years Isaac worked to marry Rebekah, only to wake up in the marriage bed with her older sister Leah, and work another seven years for the woman he loved. In the early 1900s, Jesse Livermore frequented options parlors known as bucket shops. For a small amount of money down, you had the brief right to buy or sell a security at a fixed price. If it went higher in that short amount of time, you made money. If not, you were out of luck. The bucket shops were so good at pricing option premiums they usually bucketed the orders rather than enter them.

Ye Olde Bucket Shoppe: doing business the old-fashioned way

Livermore was one of the few that did well enough in the bucket shops that he was banned. In the Roaring Twenties, Over-the-counter option writers sold puts and calls to anyone on anything that moved in the markets. Since most of the options expired worthless, they just pocketed the money. When put buyers came around to collect after 1929, most writers were long gone. A variation of this mindset may account for what and why Banks did with OTC derivatives, off-balance sheets, and out-of-the-country subsidiaries up until the 2008 crash and taxpayer bailout.

It took a bridge player named Bill Sullivan to formalize option rules to create the Chicago Board of Options Exchange in 1973. They used a normalized gaseous diffusion equation adopted by Fisher Black and Merton Scholes to price option premiums rationally.  Bill created not only standardized, transparent, market-price cleared contracts, but a private third-party AAA credit guarantor in case either side defaulted. This model falls apart during Black Swan market distributions with long tails over long times, something the man who called derivatives “weapons of mass financial destruction” cited to shareholders to rationalize writing a lot of long-term options without collateral. Now, after his firm’s credit rating was reduced, FinReg may require him to post margin, a giant margin call that may also impact earnings, since he had the integrity to mark his naked option shorts to market.

Taking It Public

Too bad Banks, Congress and Regulators did not enforce the CBOE derivative lesson before defaulting and leaning on taxpayers. The CBOE waited 37 years to go public, just before Summer 2010, and traded from 34.18 to 26.10, the fate of many hot IPOs and options.  Of interest, options may have value as a leading market sentiment indicator.

The International Securities Exchange, now the leading option exchange, developed the 20 minute daily ISEE Sentiment Indicator index that excludes market maker and firm transactions to focus exclusively on the ratio of opening Call to opening Put customer transactions. ISEE has a pretty good history of calling market turns, including the March 2009 bottom and April 2010 top. The last few days, the ISEE set annual records with up to 224 Calls bought for every 100 puts bought, suggesting market sentiment is pretty complacent, if not ebullient. We may see in the short fullness of time if the complaint of the man who claimed he could make love to 100 women in a night was valid — that he had practiced too much that afternoon. We observe AAPL at 252 had a Point & Figure downside target of 216. We leave it to former P-Coast market maker, Blue Fin fund manager and financial journalist Rick Ackerman to make profitable picks and sense of all this…

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Comments on this entry are closed.

ben July 25, 2010, 4:39 am

“now we can buy weekly options at a price almost guaranteed to absorb all price fluctuations and expire worthless.”

Ok…this is groundless stupidity. Yes there are winners and losers in options, but for every loser there is a winner. A glance at the expiring July options indicates that exactly half of options expired worthless and half expired in the money for nearly every security. If the call at a strike is worthless then the put is worth something and vice versa (save of course for those unusal instances in which the stock closes exactly at the strike).

And the comparison to the bucket shops is way off. With those options you would be sold out if the stock went against you by a few cents. They were almost invariably a sucker’s bet. With current options you can’t be margined out because you have to pay the full cash value.

I find the weekly options a great development. People can play the market on a short term basis without taking the risk of laying out the full price for a stock, and weekly options have much more volume and narrower spreads than longer term options. It is also everyone’s right to play the other side of these options and go short if they think they’re such a sucker’s bet. I’m sure Rick Cash is doing this if he has confidence in the veracity of his article.


Groundless stupidity? You ought to learn something about the topic before you tee off on Rich. Speaking as someone who has been trading options myself for more than 35 years, twelve of them on the trading floor, I’d say he got everything right. It’s a rigged game, and retail players cannot beat it. RA

ben July 26, 2010, 10:37 am

Im surprised at you Rick. I’ve been trading options for 15 years, and it’s not the length of time I traded them that proves I’m right. Neither does your 35 years of experience make you right. But the statement that the weekly options are almost guaranteed to expire worthless is wrong on its face. What is “almost guaranteed” is that half of them will expire worthless and half will expire with premium. I’m sick of people telling others the same story…of “whatever you do, don’t touch options.” I’ve made lots of money trading them, and plenty of others have too. Like any product, if you don’t know what you are doing you are likely to get burned , whether it’s options, stocks, or baseball cards. And if you do know what you’re doing, you can put the odds in your favor. I thought this to be a truism, and not something I would be assailed over for daring to criticize a comment by the great Rich Cash.

Options expiration week is when I do best trading options, and I am happy to now get an expiration week every week instead of once a month.

Rich July 24, 2010, 4:27 am

ISEE opening equity calls to puts higher today with 243% at 10:10 AM.
Tough to nervously fade trade raw skeptical emotions of fearful greed with Trailing Stops in and out, but profitable so far as weekly Big4 Asset Allocation Model Portfolio up 1040% year to date and TopTen Closely-Held Dividend Discount Value Portfolio up over 1100% the last four quarters, more than covering their costs and annual money back guarantee.
Courage and Patience often a challenge near turning points. Primary trend still down nominally since Oct 2007 and 2000 in terms of gold, despite fast-talking headliners broadcasting one-month high with SPX 1100 like March 2009 redux Stress Test.
Mutual equity funds sold off as ETFs sold up, especially commodity ETFs hampered by cotango rollovers building in losses. HFT three quarters of market and did not work so well Q2. QE2 a fantasy since QE1 did not work. Deflation may be about to rear an ugly Kracken head across all asset categories. Light volume ramped markets may lose by default and no Insider Buying to match pushed CEO Polls. The market climbed not a wall of worry, but hurdled a ditch of apathy. Gold pointed the way down. Time will always tell. Going on vacation and wish all of Rick’s Pick’s many thriving subscribers well…

Monty July 23, 2010, 10:19 pm

gary leibowitz,

are you suggesting a downturn after the run-up in the next day or two?

gary leibowitz July 23, 2010, 7:26 pm

As an aside: Saw your SPX price target today. An impulse wave to 1143 is right where I predict this will go. It could happen over the next 2 trading days. I am anticipating a nice run-up today and a follow thru Monday. That would also satisfy a Fibonacci turn-date. Your bear low is between 840 and 440? My take, if history does repeat we should see an initial low breaking 735 and possibly 666.

Rich July 24, 2010, 1:14 am

Wowee, how about 41 SPX points by 10:07 Monday now that the Corporate CEO Poll lured anyone left with cash into the bull trap…?

joeyman9 July 23, 2010, 5:23 pm

That above should read: At least by selling the options the worst thing that can happen (excluding the risk of owning the underlying) is that you wind up with CASH on a covered call….

joeyman9 July 23, 2010, 5:20 pm

Of course, note that the bias in the article is towards those who buy options. My experience shows me it is better to sell options (either covered calls or cash covered puts) than to buy them (of course there are exceptional circumstances that come along to go long but I temper my enthusiasm and only use them for very small positions – first question I ask myself is, How much can you afford to lose?). At least by selling the options the worst thing that can happen (excluding the risk of owning the underlying) is that you wind up with call on a covered call or the stock on a cash covered put. My experience with this strategy gets me about 35% per year…..not fantastic but surely not too shabby either.

JohnJay July 23, 2010, 4:28 pm

Bucket shop.
Put the money in your pocket.
If the market crashes, disappear!
Those were the days!
Joe K and Jesse L!
A lot more fun than High Frequency Trading I bet!
Plus you could hang out in a cigar smoke filled room, wearing a Derby hat!

Ron July 23, 2010, 4:21 pm

Hi Rick,
I’m afraid that your Biblical history is off just slightly. It was Jacob who worked 7 years for Rachel, only to wake up married to Leah. Isaac and Rebekah were Jacob’s parents. 🙂

Rich July 24, 2010, 1:08 am

Absolutely right…

Benjamin July 23, 2010, 12:07 pm

“Tuesday, they were extolling weekly call options on AAPL with 70% volatility premiums. ”

I don’t understand these option things, but I sure as heck undertstood that. Seventy cents to the dollar. One week to beat it. Just who are the people buying these things?! And more importantly, why? Hmmm… Would it be going too far to assume that our old friend the Fed is putting money into some pockets???

Jonathan July 23, 2010, 2:31 pm

Sorry to break it to you Benjamin, but you still don’t understand options. 70% vol is NOT the same things as seventy cents to the dollar…

Benjamin July 23, 2010, 3:24 pm

Well, I never did claim to understand them. Just thought I’d give understaning a shot. Anyway, premiums…


Volume seems related, but not the same thing (shrugs). All I know is that if that there was a 70% premium on gold, that would be 70 cents to the dollar. And I sure as heck wouldn’t buy that.

Benjamin July 23, 2010, 3:38 pm

Sorry, meant 70 cents more to the dollar…

Ron July 23, 2010, 4:04 pm

Sorry Benjamin, that’s still not right either.

Rich July 24, 2010, 1:11 am

Benjamin you imply a good point that options in the past became popular right before big market breaks…

sam July 23, 2010, 5:57 am

Jacob married Rebecca

Rich July 24, 2010, 1:01 am

Jacob(Israel) was Isaac and Rebekah’s son…

jon July 23, 2010, 5:19 am


Rich July 24, 2010, 1:19 am

This was written last week before AAPL gapped to 265.15 and flipped the Point & Figure Target up to 316.
In the past, P&F was unreliable around turning points.
If Rick made the argument for 316+ AAPL, would not be surprised, as Tech and Oil rode higher and higher in the late 70s while the rest of the market went south on vacation. Trailing Stops and blind luck patience work better…

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