“Heads I Win; Tails I Lose A Little” | Part 2
Larry Connors' Trading Lesson of The Day | September 18, 2024
Over the past two Trading Lessons of the Day, we’ve looked at Asymmetric Trading, one of the main drivers of wealth creation for traders.
The goal is to identify high-conviction positions and then, more importantly, structure your trades where your potential returns are many times your initial risk.
Or as Mohnish Pabrai aptly states in his book The Dhandho Investor, “Heads I Win, Tails I Lose A Little”.
How To Structure Your Asymmetric Trades
There are a handful of better ways to structure asymmetric trades. Over the next few lessons, we’ll look at them starting today with long options. For a fixed, predetermined amount of money, you have pre-defined risk (the max risk is guaranteed unlike stops) with the potential for unlimited returns.
As I mentioned last week, I know two traders very well who made generational wealth from one single options trade. Each was long options whose underlying market experienced massive moves.
Their risk was predetermined. Their gains were thousands of times that amount.
Before going on, I want to remind you that options come with risk. Make sure you understand their risks and go as far as reading the risk disclosure documents your broker and the options exchanges provide.
Today, we’ll look at the most basic and easiest to understand options position to put on with the objective of risking one unit to make many units. It’s the very simple, yet often effective, long call or put position.
Asymmetric Strategy 1 - Long Options
I’m going to assume you know what a long option is. If you don’t you can find the description online.
A long call or long put has the ultimate asymmetric structure built into it.
For example, if you are hypothetically bullish on a $30 stock and buy a call on this stock for $1 and the stock rises to $40 your calls are worth at least $10.
In exchange for risking $100 dollars per contract, you made 10x your money.
If the stock went to $50, you made 20x your money.
Your total risk was predetermined to the amount of the option you paid (plus the transaction cost if any).
Your potential gain was unlimited.
The stock has no theoretical ceiling, therefore allowing for the potential of unlimited upside returns.
As you know though, there are two sides to options trading. For example, time decay works against you. The call has an expiration date. If the stock is below $31 on expiration date, it’s a loss. If it’s below $30, it’s a full loss. You lost the initial capital (the one unit risk of the option).
The same can be done with puts. We all know equity markets tend to drop faster and sharper as a whole than they rise. Unlike a long call though, which can theoretically move up an unlimited amount, the most the underlying stock can drop to is zero.
In the hypothetical example above, if we paid $1 for a 30 put, the max that can be made is turning that $1,000 into $30,000 per contract (any of us will gladly take making 30 times our money though!).
In reality, the majority of the moves will not be this large. It’s often risking one fixed dollar unit with the goal of making 2, 3 or 4 times the risk. Then a few moves will potentially be larger, plus throw in the occasional outlier move and the gains can be substantially higher. In the example of the two traders I personally know, their gains created lifetime generational wealth.
The other advantage of long options is that not only is your dollar risk contained, you tie up far less capital.
For example, I’ve been heavily invested in AI and AI-related companies since the spring of 2023. I used the technology and immediately saw that this was the 1990’s version of the internet which I traded through. This was likely going to be a revolutionary technology just like the internet was and the upside potential was going to be substantial.
Structuring a Long-dated Asymmetrical Options Position in Apple
A short while ago I recognized that Apple had the potential to be the predominant player in B2C AI.
Up until now, most AI companies have been feeding B2B. Apple, with its iPhone, already has a built in audience. In the US alone there are over 130 million iPhone users. Globally, it’s even higher.
Drop in AI and soon hundreds of millions of people will have instant access to AI in the palms of their hands.
I know enough about AI to realize that the opportunity was tremendous. I also know that companies like Google, have botched these consumer rollout attempts a few times. Longer term they’ll all get it right – the risk is when.
Apple was trading around $180 a share when I began putting on long-dated call positions.
The philosophy is identical to what we discussed yesterday…”Heads I Win, Tails I Lose a Little”.
Putting these pieces together I asked myself how can I put up the least amount of capital, and get the greatest potential reward on the capital, plus be there not on a short-term basis but on a longer term basis to allow them to eventually get the roll out right?
Instead of tying up approximately $18,000 for every 100 shares of stock (and theoretically risking the entire amount), how can I construct an asymmetric position which can make many times my money.
Here you will see my position. The purchase price for the calls was $20.81. The recent price has already doubled to $43.50.
Please also note these options go out to June 18, 2026. This gives Apple ample time to get AI fully integrated into the iPhone.
If I purchased the stock, and it rose to $360 in two years, I’d double my money. That’s a good return but it’s not an asymmetrical return. Plus, it ties up a lot of capital which can be better utilized elsewhere.
With the options, if the stock does the same thing, my position will be worth at least $160 (8x my money). And we’d all like making 8x our money, especially within two years.
This is classic asymmetric trading. Risking one unit in order to make many units. In this scenario it’s the difference between making 800% compared to 100%.
This same type of trade structure can be done so many ways, including all time frames. As I mentioned last week, a trader reportedly turned $10,000 in 0DTE long call options into millions in a few hours on an intraday massive explosion to the upside in SPY.
This is our baseline foundation – there’s more to this both with pluses and minuses. The takeaway today is that long options, done patiently and properly have amongst the highest potential for asymmetric returns.
Whenever you’re looking at a favorable set-up, one that you have high conviction, ask yourself: “how can I structure this trade where I take the least amount of dollar risk in order to make the greatest returns if I’m correct”?
This analysis will be your guiding light as you make your move to becoming an Asymmetric Trader.
In tomorrow’s Trading Lesson Of The Day we’ll continue to build on this even further.
I’ll see you tomorrow!
Larry Connors
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