January 4, 2023
 min read

Why You Should Never Buy Put Options

The rise of low-cost and zero commission brokerages such as Robinhood have enabled these traders to speculate like never before.

Options have become a popular asset class—this is evermore true in intense bull markets and bear markets. The natural leverage involved in options allows participants to make sizable returns on minimal investment. Because of this characteristic, it appeals a lot to retail traders.

The rise of low-cost and zero commission brokerages such as Robinhood have enabled these traders to speculate like never before. Whilst options in of themselves are a great tool, the majority of traders simply don't understand how complex they are. Think a stock is going down? BUY A PUT! Convinced that your favorite stock is going to crush the upcoming earnings? BUYA CALL! You may not believe me, but some of these discount brokerages have ran campaigns like this in the past on their platform in an attempt to “educate "their clients about their product offerings. It has been nothing more than misleading statements and I would even call it financial fraud.

Generally speaking, most retail traders with limited experience should simply never buy options to begin with. But in efforts to keep this blog short, I will focus on put options on the general market(S&P 500, SPY/SPX).

Put Options on the S&P 500: All the forces in the world are against you, this is the lowest probability trade in most market conditions. Let me explain;

1.     Markets can either rise, fall, or not move much in either direction. Everything else constant, your probability to win based purely on outcomes is (1/3) = 33%.

2.     100 years of market data tells us that markets generally rise over time. Why would you want to bet against this?

3.     Yes, markets do fall, but only at certain points in time.

4.     However, the market is so smart that usually it will discount fear into the price you are paying if it is convinced that bad outcomes are to occur (market falling). As a result, you need a bigger downside move now for the trade to work.

a.     Think of it like buying flood insurance in a time where everyone is expecting a big flood to occur, Or heck, even after the flood has happened (at heightened fear of future floods).You will most likely always overpay.

5.     As a result, you have to be absolutely methodical with the timing of the trade.

6.     Time is against you. As with all long option trades, time decay happens daily and the desired out come has to occur before expiration.

The only time buying pure put options ever makes sense is if you are completely convinced that the market is going to go down to or near your target price, within the desired time, and if you believe that the price you are paying is fair. In my own experience, this is one of the rarest types of trades with the lowest probability of success and unless you have a demonstrated ability to be able to predict where, and WHEN (the market will fall), then you should simply not do it.

The reason I have made this blog post is because we are currently in a violent bear market with lots of fear surrounding a possible recession and a high probability of the S&P 500 making new lows within the next 12 months. Whist bear markets create more opportunity than usual for traders, most retail traders simply should not buy put options on the market to begin with. Puts are very expensive and violent bear markets are even more famous for violent counter-trend rallies. When buying puts, not only are you betting against the market, you are also betting against the house (the option sellers). If you are convinced the market is going to go down; a better probability decision is to simply raise cash and buy it at a lower price.

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