Option Trader’s Guide to the Markets (and Life)

Trading options means thinking (and acting) with the inner quant brain. Once you get into the mindset, that analytical thinking might show up as you assess other investments—and other life decisions.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Book titled options manifesto: Option trader's guide to the markets
5 min read
Photo by Dan Saelinger

Key Takeaways

  • Understand how to develop a mathematical mindset to approach trading
  • Education and assessment are important when it comes to managing uncertainties
  • Analyze your risks, potential payoffs, and the odds at every stage of a trade

It remains a powerful phrase: “How you do anything is how you do everything.” For an option trader, the how-you-do-it part involves checking the max payoff, max risk, potential return on capital, and the probabilities of each possible outcome at every point along the way. And then you make a decision.

Trading and life are not often mutually exclusive. Many traders find that as their options knowledge grows, those insights begin to shape everyday choices. Let’s consider a trader’s take on a few routine decisions.

Life Through an Options Lens

There was a study a few years ago that suggested humans make 35,000 decisions per day. Although some have called that statistic overblown, let’s agree that we all make a lot of (mostly low-stakes) choices. And the option trader’s brain might send those decisions through the same cognitive process. A sampling:

  • You’re out of milk, and Junior offers to run to the store, so you toss him $20. You’ve been on both sides of this trade—first as a kid, and now as a parent. “What’s the probability or delta that I’m ever going to see change?” you mutter to yourself. 

  • You do a favor for a friend. It was a kindness—it didn’t cost you anything, so in a way, it’s a free call that might or might not pay off someday should you ever be in need.

  • You’re late for an important meeting, and the busy street you’re about to cross has started its 10-second “don’t walk” countdown. As an option trader, you’re weighing the gamma (speed) of an approaching car against the theta of the walk signal against the max payoff and risk (getting to your meeting or getting hit by a car). 

You get the idea. 

But looking at life through the options lens is more than just the language of greeks and lingo of strategy. It’s about taking those daily decisions and running them through the same cognitive process you do with an options trade.

Four Reasons to Adapt the Analytical Mindset

You can always quantify an options trade. The thinkorswim® platform is chock full of metrics—from the theoretical values and greeks under the Trade tab, to the “what-if” risk profiles and probability analysis tools under the Analyze tab, and much more (see figure 1). In other words, you assess and then decide. 

risk profile of different volatility levels on thinkorswim

FIGURE 1: PUT A NUMBER ON IT. Fire up the thinkorswim platform, punch up an order ticket (real or simulated), and see the risk and potential reward up and down the price chart. Play with different volatility levels, roll ahead to any date, or even fast-forward to the next expiration date. Chart source: The thinkorswim platform. For illustrative purposes only. Past performance does not guarantee future results.

As a trader, you might use that mathematical mindset to approach other areas of investing (and life) because you’re running it all through that same options filter. Let’s look at four reasons that may be a good idea.

1 – You won’t stay married to a trade.

The options clock is always ticking toward expiration. But your other investments have theta too: opportunity cost. Is a trade not panning out as you thought? How much time should you allow? More importantly, what opportunities are you leaving on the table because your risk capital is deployed in this trade?

Look at the decisions in your investments (and beyond) and consider giving them an expiration date. Giving them an end point gives them a theta. You might find you’ve become nimbler and less emotional while making decisions.

2 – You’ll give yourself better odds.

Options are all about uncertainty. The ebb and flow of volatility—along with the passage of time—changes the amount of uncertainty in the equation and thus affects the delta of an option. There’s always uncertainty—even, at times, an hour before expiration. So, you assess the risk and reward, give yourself good odds, and do your best to manage the uncertainty. 

With a non-options trade, education and assessment are the keys to managing what’s unknown. “What’s the delta?” becomes a question you repeatedly ask yourself. You check the charts, compare the fundamental ratios, and keep an eye on the news. Trading on momentum becomes an exercise not of following the herd but of following the math (see “The Nuts and Bolts of MOMO Trading”).

3 – You’ll stop chasing trades. 

Every golfer knows (although some choose to ignore) that when deciding that next shot, you should go with the most likely outcome, not the best-case outcome. Trying to decide between a 200-yard carry over a pond and a layup in front of it? Don’t think about that one time you pulled it off pro-style. Think about the nine times you splashed it short.

Traders should consider looking at every trade, investment, and most everyday decisions as a risk graph with the worst-case scenario drawn right in (see figure 1). Basically, you’re looking for reasons not to choose a certain course of action. If you can eliminate those reasons so the odds are tilted more in your favor, you can stop chasing trades. 

4 – You’ll accept the bad with the good.

One of the first lessons an option trader learns is that things don’t always go as planned. The good-odds trade sometimes plays out the bad way. Even a 90% success rate—which is technically achievable by options standards but hard to duplicate in the real world—still loses one out of 10 times, statistically speaking.  

The trader brain knows you don’t have to “win ’em all.” Instead, you can try to manage the odds such that your goal is to have your winners outpace your losers—from a money standpoint, not necessarily in terms of percentages. 

And you can’t learn everything from a book; sometimes you have to live it. It’s like the old adage about plans versus planning and how plans go out the window when the bullets start flying. In effect, you learn from practice. And paperMoney® on thinkorswim can help you simulate that “skin in the game” as you test strategies and ideas in a virtual trading environment.

Behavioral Econ 101

Making decisions is never as easy as textbooks would have you believe. For one thing, they assume all investors have equal access to information and that they act with the same degree of rationality. Instinctively, the option trader knows that’s not the real world. Money can play tricks on the mind.

In fact, Charles Schwab has an entire podcast series—Choiceology—that explores the lessons of behavioral economics to help traders and investors make decisions with their eyes wide open.  

It’s another piece of that same puzzle—making sense of the decisions we make. Option traders generally look at risk, potential payoff, and the odds at every stage of the game, while letting the math guide them. 

And if that’s how you do that one thing—thinking and acting with a trading brain—you might find it’s how you do everything.

Doug Ashburn is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.

Key Takeaways

  • Understand how to develop a mathematical mindset to approach trading
  • Education and assessment are important when it comes to managing uncertainties
  • Analyze your risks, potential payoffs, and the odds at every stage of a trade
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