Before You Start Option Trading, Do the Maths

Trading options is often touted as an intelligent way to invest; smaller amounts of money expose you to larger profits, and your losses are capped. But the truth is that most traders will lose money using this strategy.

Instead of having to purchase shares outright, option traders can create their investing strategy based on various market conditions. You can use options to hedge against risk, generate income, or bet on price direction using contracts tied to an underlying asset like shares, ETFs, or indexes.

However, unlike a lottery ticket, options are a financial instrument with a mathematical price model. If you don’t pay attention to the numbers behind the model, you are stacking the odds against yourself. While the theoretical concept of defined risk exists, it doesn’t guarantee you will make money.

In order for options trading to be successful, you need to establish and maintain a disciplined method of implementing your plan. That’s why it’s essential to calculate the numbers before trading anything through any trading platform, and with the help of a stock options calculator, you can slow down to think carefully about what events must occur to make your trade successful.

What an Options Contract Actually Represents

There are two different kinds of options contracts: call options and put options. A call option gives the right, but not the obligation, to purchase an underlying asset at a predetermined strike price before an expiration date.

A put option gives you the right to sell the underlying asset under the same setup. The “not the obligation” option is significant in that you can walk away without having to make the purchase, and only lose your premium.

Typically, each options contract represents 100 shares of an underlying security, which is where leverage comes into play. You’re not purchasing the underlying shares yourself; you’re just paying for the right to conduct the purchase at predetermined terms.

Options are much more capital-efficient than stock ownership. You are able to shape your exposure with less cash than you would otherwise need if you purchased the underlying shares outright. Losing precision is the trade-off in that if the correct price and/or timing isn’t reached, then the option will essentially go nowhere, whereas the stock might still be in a good position.

Options Contracts Are Probabilities, Not Predictions

This is where a lot of traders make mistakes. They often think that options trading is all about calling the direction of the market, up or down. Direction is only part of the options trading equation. Option prices already reflect expectations about future price movements, volatility, interest rates, and the prevailing market price.

When you purchase an option, you are essentially paying for the probability that the underlying asset’s price will rise to a certain level before expiry. If there is a high probability that the price of the underlying will reach the specified price, then this will, in turn, translate into a higher option price.

Markets do not pay attention to your opinions; they only care about odds. Therefore, trading options without taking the proper approach to probability is similar to betting on an outcome without checking the payout table.

Why Most Options Losses Are Mathematically Predictable

Cheap options appear attractive and seem to be a good opportunity to purchase at a lower cost. Most of those cheap contracts are out of the money. Simply stated, in order to gain any intrinsic value from a cheap option, the price of the stock must move above the strike price of the option.

Statistically speaking, the majority of options expire worthless, which is not a matter of opinion. It is a simple fact that reflects how distribution works. In most cases, option buyers will only lose the premium paid, which happens often.

For the price of underlying stocks to move high enough, fast enough, before the options expire, you must be on the money. If any of those conditions are not fulfilled, the contract reduces quietly to zero.

Time Decay and Expiration Date Work Against Unprepared Traders

In options trading, time is never neutral. As the expiry approaches, the option prices decrease as a result of time decay (theta). Near the expiration date, the time decay accelerates rapidly.

New traders often become frustrated when the underlying security is moving in the right direction, yet the option they hold is still losing value. If the price movements are slow or choppy during the trading session, the premium will decay over time, and the decay will eat away at your profits. You do not have to go against the market price to experience this loss; your trade just has to take longer to hit its target.

Volatility Is a Cost Embedded in Option Prices

Volatility is not a bonus; it is a cost that you must pay upfront. Option prices rise as volatility increases, and, as a result, traders frequently make emotional decisions and overpay for options in a fearful environment, causing the inflated market value.

If volatility decreases after you enter a trade, option prices can decrease, even if the underlying stock in the current market price is barely moving. This is known as volatility contraction.

Interest rates and additional costs, such as commissions, are generally not as well understood and, as such, they typically have a smaller impact on option prices when compared to the effect that volatility has when misunderstood. Anyone trading options without considering volatility is operating with no information.

Break Even, Risk, and Why Maths Turns Options Into Strategy

Every options trade has a breakeven point. This is the price an underlying asset must reach for your trade to recover the premium paid. The only way to determine a position’s intrinsic value is when the underlying asset trades above the strike/exercise price. Until that happens, the option is essentially running on borrowed time.

The price movement required for an options trade is not wishful thinking but a specific number. How often does this stock move that far within this timeframe under similar market conditions? If you don’t know that, you are just hoping for the best.

Most traders confuse defined risk with capping losses. Yes, a trader can cap their losses when buying options, but capping is not the same as controlled risk. Controlled risk takes into account the trader’s risk tolerance.

When traders continually suffer small losses from multiple trades, the cumulative downside risk adds up. If a trader sells options contracts, the downside or potential return becomes greater due to the earnings potential and pre-existing margin balance. One bad streak of trades can wipe out several months of profits.

A risk management plan is effective towards managing positions in terms of position sizing, exit rules and limits to exposure, rather than on the basis of a choice to create a trade. These three aspects of risk management represent the division between making a trade vs. giving a donation. Over time, probability and expected value convert the concept of trading options into a structured process.

Also, as an example, basic option trading strategies, like a covered call, demonstrate how a trader can create a means to generate income through planning ahead. The next step would be the use of vertical spreads, which illustrate how more complex trading strategies use mathematics in order to control both risk and rewards in an intentional manner.

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More Recommended Ebike/Scooters

Check out these other ebikes and scooters I've reviewed:

Urban Arrow Ebike – Last year, I made one of the largest purchases I’ve ever made – I bought a $9,000 electric cargo bike from Urban Arrow. In my Urban Arrow review, I will discuss what it is and why I decided to buy this bike, as well as discuss how impactful a bike like this can be on your journey to financial independence.
Troxus Explorer Step-Thru Ebike – The Troxus Explorer Step-Thru is a fat-tire ebike that I’ve had the pleasure of riding for a while now. It has amazing power, great looks, and awesome range. If you’re looking for a great fat-tire ebike that offers a lot for the price, the Troxus Explorer Step-Thru is definitely one for you to consider. Check out my Troxus Explorer Step-Thru Review.
Hovsco HovBeta Ebike – The HovBeta is a folding ebike with great specs and a lot of interesting features, and importantly, it’s sold at a good price point. I’ve had a blast commuting with it and using it to do deliveries with DoorDash, Uber Eats, and Grubhub. Check out my Hovsco HovBeta Ebike Review.
Vanpowers Manidae Ebike – The Vanpowers Manidae is a fat tire ebike that I’ve been riding as my primary winter commuting bike and have also been using it to do food delivery with apps like DoorDash, Uber Eats, and Grubhub. After clocking in a decent number of miles with this ebike, I wanted to write a post sharing what my experience with the Vanpowers Manidae ebike has been like. Check out my Vanpowers Manidae Review.
Sohamo S3 Step-Thru Folding EBike Review – A Great Value Folding Ebike – The Sohamo S3 Step-Thru Folding Ebike is an entry-level folding ebike that offers a lot of value for the price point. I’ve been riding the Sohamo S3 for a while now, putting the bike through its paces, and I have to say, this bike has exceeded all of my expectations. Check out my Sohamo Review.
KBO Flip Ebike – The KBO Flip is an excellent bike. I’ve had a great time riding it and think it’s a versatile bike that can be used for a lot of purposes and can fit a variety of lifestyles. It’s worked out great for me as a general commuter bike and as a food delivery bike. Check out my KBO Flip Review.
Hiboy P7 Commuter Ebike – The Hiboy P7 is an excellent electric commuter bike that’s offered at an affordable price point. The range and speed of this bike are both very good, so you won’t have any trouble getting anywhere you need to go with it. As a food delivery vehicle, this is also good – with how much range it offers, you’ll be able to work all day on a single charge. Check out my Hiboy P7 Commuter Electric Bike Review.
Himiway Escape Ebike – The Himiway Escape is an interesting bike for anyone looking for a moped-style ebike. If you’re a gig economy worker, the Himiway Escape is particularly interesting and it’s possible to think of it as an investment, especially if you can opt to do deliveries with the Himiway versus using a car. It’s not cheap, but you can definitely make your money back when you compare the mileage you’ll put on your car versus using an ebike. Check out my Himiway Escape Bike Review.
Espin Sport Ebike – The Espin Sport is a good ebike for someone who is looking for an ebike that feels and rides more like a regular bike. There are many ebikes that are really only bikes in name. In reality, they’re basically electric mopeds. The Espin Sport, by contrast, is a bike you could probably ride without the battery and you’d feel like you’re just riding a regular bike. Check out my Espin Sport Review.
Varla Eagle One Scooter – The Varla Eagle One is an excellent scooter that can make sense for a lot of people. It can work as a primary mode of transportation. You can use it to work on gig economy apps like DoorDash, Uber Eats, and Grubhub. And it can also be a recreational vehicle if you’d prefer to use it for that. Check out my Varla Eagle One Review.
Varla Falcon Scooter – The Varla Falcon is an excellent scooter that offers a good amount of power at a lower price point compared to more powerful scooters. It’s not exactly an entry-level scooter, nor is it a high-powered scooter. I think it fits somewhere in-between those two categories – an intermediate scooter if I had to give it a category. Check out my Varla Falcon Review.
Hiboy S2 Scooter – The Hiboy S2 is an excellent entry-level commuter scooter that's perfect for someone looking to save some money in transportation costs and improve their commute. Check out my Hiboy S2 Review.
Hiboy S2R Scooter – The Hiboy S2R is one of the more interesting electric scooters I’ve been able to test out. It’s not a high-powered scooter, but for an everyday transport option, it’s very useful, especially given some of the unique features that it has. Indeed, for the price, the Hiboy S2R might be the best value scooter I’ve used. Check out my Hiboy S2R Review.
Fucare H3 Scooter – The Fucare H3 is a fun scooter and I’ve enjoyed testing it out. For a daily commuter or quick trips or errands, the Fucare H3 is probably the scooter I’ll use. It’s portable and easy to maneuver, so it’s just easier to take on the road when I need it. Check out my Fucare H3 Scooter Review.

More Recommended Investing App Bonuses

For additional investing app bonuses, be sure to check out the ones below:

M1 Finance ($75) – This is a great robo-advisor that has no fees and allows you to create a customized portfolio based on your risk tolerance. You also get $75 for opening an account. Check out my M1 Finance Referral Bonus – Step-By-Step Guide.
SoFi Invest ($25) – SoFi Invest is an easy brokerage account bonus that you can earn with just a few minutes of work. Use my SoFi Invest referral link, fund your SoFi Invest brokerage account with just $10 and you’ll get $25 of free stock. I also have a step-by-step guide for the SoFi Invest referral bonus.
Robinhood (1 free stock) – Robinhood gives you a free stock valued between $2.50-$225 if you open an account using my referral link.
Public (1 free stock) - Public gives you a free stock valued between $3-$70 if you open an account using my referral link.

More Recommended Bank Account Bonuses

If you’re looking for more easy bank bonuses, check out the below options. These bonuses are all easy to earn and have no fees or minimum balance requirements to worry about.

Ally Bank ($100) – Of all the banks out there, Ally is, without a doubt, my favorite. At the moment, Ally is offering $100 to customers who open an eligible Ally account and meet the requirements. Here are the step-by-step directions to earn your Ally Bank referral bonus.
Chime ($100) - Chime is a free bank account that offers a referral bonus if you use a referral link and complete a direct deposit of $200 or more. In practice, any ACH transfer into this account triggers the bonus. This bonus is easy to earn and posts instantly, so you’ll know if you met the requirements as soon as you move money into the account. I wrote a step-by-step guide on how to earn your Chime referral bonus that I recommend you check out.
US Bank Business ($400/$1200) – This is a fairly easy bank bonus to earn, since there are no direct deposit requirements. In addition, you can open the Silver Business Checking account, which comes with no monthly fees. Check out how to earn this big bonus here.
Current ($50) – Current is a free fintech bank that’s offering new users a $50 referral bonus after signing up for an account using a referral link. Current is an easy bonus to earn and also gives you access to three savings accounts that pay you 4% interest on up to $2,000. That means you can put away up to $6,000 earning 4% interest. That’s very good and makes Current an account I recommend to everyone. Check out my step-by-step guide on how to earn your Current Bank bonus.
Novo Bank ($40) - Novo bank is a free business checking account that’s currently offering a $40 bonus if you open a Novo business checking account using a referral link. In addition to being a good bank bonus, Novo is also a good business checking account. It has no monthly fees or minimum balance requirements and operates a good app and website. Indeed, it’s the business checking account I currently use for this blog. Check out my post on how to easily open a Novo account.
Varo ($25) – Varo is a free fintech banking app similar to Chime or Current. It’s currently offering a $25 bonus to new users that open a new Varo account with a referral link. The bonus for this bank is very easy to meet, all you need to do is spend $20 within 30 days of opening your Varo account. Check out my step-by-step guide to learn how to earn this bonus.

Kevin is an attorney and the blogger behind Financial Panther, a blog about personal finance, travel hacking, and side hustling using the gig economy. He paid off $87,000 worth of student loans in just 2.5 years by choosing not to live like a big shot lawyer.

Kevin is passionate about earning money using the gig economy and you can see all the ways he makes extra income every month in his side hustle reports.

Kevin is also big on using the latest fintech apps to improve his finances. Some of Kevin's favorite fintech apps include:

SoFi Money. A really good checking account with absolutely no fees. You'll get a $25 referral bonus if you open a SoFi Money account with a referral link, and an additional $300 if you complete a direct deposit.
5% Savings Accounts. I'm currently getting 5.24% interest on my savings through a company called Raisin. Opening a Raisin account takes minutes to complete, it's free, and all of your funds are FDIC-insured. I explain how it works, why I'm now using it to store my emergency fund and any other cash savings I have, and why I recommend everyone check it out in this review.
US Bank Business. US Bank is currently offering new business customers a $400/$1200 signup bonus after opening a new account and meeting certain requirements.
M1 Finance. This is a great robo-advisor that has no fees and allows you to create a customized portfolio based on your risk tolerance. You also get $75 for opening an account.
Empower. One of best free apps you can use to monitor your portfolio and track your net worth. This is one of the apps I use to track my financial accounts.

Feel free to send Kevin a message here.