Calling All Beginners

To Debug My New Book

In my spare time I've been working on a beginners book on Options Trading that would be very simple to understand, and at the same time, teach correct trading mindset principles on Day Zero.

My wife is a Yoga Teach and Doctor or Oriental Medicine with no experience at all trading options.with no experience at all trading options. I asked her to read this chapter and incorporated her feedback, now it's your turn.

Here is Chapter One, let me know if I can make it even easier. Post your feedback in the comment section. All contributors get an acknowledgement in the book when it comes out.

Chapter One : Options Contracts For Someone That Might Want To Buy Your House

Imagine that you live in a house that is worth 100,000-. This is a nice round number and also happened to be the realistic price of a home when I first taught a class in options pricing models about thirty years ago.

A real estate speculator offers to pay you 1500- in cash. In return, for the next year, the speculator can buy your home for 125K. If he doesn't buy within a year, you keep the money. If he does buy, you have to sell the home for 125K and move out right away. Plus you get to keep the 1500- in cash. So the total sales proceeds are 126,500 if he buys. If he doesn't buy the house, you keep the 1500-.

Why is the speculator paying you 1500- for the right to buy the home at 125K? After all, he could just buy the home for 100K which is a lot cheaper than 126,500.

Let's look at a couple of scenarios.

In six months, petroleum engineers discover a new oil field under your back yard. The market value of your property is now 5 million dollars based on the discovery. The speculator exercises the contract you signed and buys the house from you for 125K. Then turns around and sells it for 5 million. You feel really bad about missing out on the 4,873,500 profit and wonder if there was a way you could get a piece of the gain. After all, the speculator had to know something was up when he signed the contract and paid the cash. You run the idea by your attorney, but discover that you are out of luck. Your legal contract is binding and there aren't any insider trading laws for oil fields discovered on private property. So for 1500- you just gave away a 5 million dollar profit. Bummer.

Here's another scenario:

Instead of finding oil on your property, an environmental audit discovers asbestos exposure which cuts the value of your home in half, to 50K instead of 100K. No way is the speculator going to exercise his right to buy a 50K house loaded with asbestos for the price of 125K. He decides to eat the 1500- loss and is breathes a sigh of relief that he just dodged a bullet. You, on the other hand, have to deal with an expensive cleanup bill that dwarfs the 1500- you received. Not to mention any adverse health effects from the asbestos you may have breathed in. The 1500- is better than nothing, but it does not provide a lot of protection for a big move down in your property value.

The third case is where nothing happens, the home is worth 100,000 in one year and you keep the money.

This lesson provides insights into the key drivers of options trading: probability of success, and magnitude of success or failure under a range of scenarios that might or might not materialize in real life.

What is the probability of the oil well scenario? The asbestos scenario? And the nothing changed scenario?

Equally important, what is the magnitude of gain/loss?

Weighing the magnitude of gain vs. probability of outcome is a good skill to have.

Back in the 1970s when the government legalized gambling by renaming what used to be called ‘numbers rackets’ and instead calling them ‘lottery tickets,’ most of my uncles and aunts went out and bought the newfangled lottery tickets for fifty cents a piece. My mathematical genius grandmother, on the other hand, put fifty cents a week into a piggy bank. After one year, she had 26 dollars in cash and the uncles and aunts all had 26- dollars in losses on their lottery ticket ‘investments.’ Side note: this is the same grandmother who never used a cash register or, much later, a calculator in her retail paint and wallpaper store because they were way too slow compared with her preferred method of doing everything in her head.

DISCLAIMER: All content on he Nuclear Option Substack is for Education and Information Purposes Only. It is not a recommendation or solicitation to buy or sell any security. Before trading, consult your Professional Financial Advisor and read the booklet Characteristics and Risks of Standardized Options Contracts, published by the Options Clearing Corporation.