The Power of Optionality: Small Bets, Big Payoffs
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Welcome the money for the rest of us. This is a personal financial on money, how IT works, how to invest IT in, how to live without worrying about IT. And we your host, David stein.

Today is episode 4 ninety two。 It's titled the power of optionality small bets, big payoff, a money for the rest. We have discussed options in the past, but usually financial options such as the options or put options on stocks, but there are other types of options, and particularly options outside of the financial market.

Options are something where you pay a premium, a small payment for the right, but not the obligation to exercise that option with the financial option. Typically, there's an s metro payoff s the upside is much greater than the downside because the downside is limited to the premium paid. One of the first examples of financial options is found in politics by aristotle.

In that volume, aristotle shares the story of dailies. And my leaders daily was a philosopher, but he didn't have much money because he spent time on other things and people would beat him. And I listen to some of his thoughts because he wasn't very wealthy, so at least decided he was gonna some money.

One winter. He predicted that there was going to be a bountiful olive harvest that summer. And aristotle suggested was dairy's knowledge, astronomy that allowed him to make that prediction.

Sales went all around the area and put deposits down on the all the presses. And that secured him the right to use all of those Prices. That summer, he had an option.

He had the right, but not the obligation to use the olive Prices. IT was a bountiful harvest, and bailes leased out the other presses at very high rate because there are such demand and made a lot of money. In this example, the the downside was just a deposit that he put, that all we would have lost the premium.

The opposite was the profit from leasing this out. I have a friend that would do this in real estate. He would buy options for the right, but not the obligation to purchase a piece of property.

And he would have the right of first refusal until he would put down that option. And then he could find a buyer for the piece of property and then make the profit. In the stock market, we are most familiar with call options and put options.

A call option gives you the right to purchase a stock at a specific Price. That Price is called the strike Price. Example of you bought a call option on apple stock, you think apple is going to go above a certain level. If the stock did go above that level, IT exceeded the strike Price, you could goodbye that stock the apple stock at a lower Price in salad at a higher Price.

In reality, once that option gets in the money and that is above the strike Price for a call option, you could just close out by reversing the purchase sensually, selling the call option that you just bought and lock in the profit put option similar. But IT gives you the right to sell a security at a specific Price. If the security falls below the strike Price, you can buy the security in the market at a lower Price and then sell IT at your predetermined higher Price to strike Price reality again, just would close out the put option for a call option and a production.

The profit is the difference between the market Price either above for a call option or below the strike Price for a put option. Is that difference less? The premium paid options have a symmetrical payoff.

s. The upside is greater than the downside because the downside essentially is the premium paid. And because of this assumes tric pyo s structure, they're positively skilled, which means the average outcome is greater than the medium or middle outcome.

We discussed positive students a few episodes ago. If most of the time an option expires, worthless, but a few times IT gets in the money and you there's a massive upside that would bring up the overall average. But the meeting, I would just be whatever the premium paid is.

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Upgrade you're selling today shop fy dot com slash David. Nether element of options is volatility increases the value of options. Premiums on a stock index are lower than the premiums on an individual stock.

An individual stock is more value to which made is more likely to exceed the strike Price for a call option or fall below the strike Price for a put option. That's the actual volatility. But as humans, we have lots of version.

We don't like to lose money. We also have the fear missing out of gains. And as result, the demand for stock options is very high. Investors are willing to pay more than what the options are really worth based on the historical volatility of the stock market and the underline stocks that make up the stock market.

Not the way to say that is the imployed volatility Prices in the stock option is greater than actual relatives, which means we are paying more than we should to hedge against losses or to be able to take advantage of upside gains. And as a result, you can actually make money systematically selling options. I've done this the last four years by investing in the wisdom tree, C B O E S M P five hundred put right strategy etf tickers P U T W.

This etf sponsor cells put options on the S M P five hundred every thirty days. There are thirty days options. They collect the premium. And then if the stock market, the S M P five hundred, falls during the month, those losses get passed on the etf because they have full downside exposure a month at a time for the stock market, but because the premiums for put options are higher than they, they should be.

Based on the history of volatility, this etf has earned nine percent analyze over the past five years and seven percent analyzed over the past three years over longer term periods as strategies aren't about six percent now, you are exposed to stock market losses if the stock market fell twenty percent in a month. But over time, just because of the demand for protection for that option, selling that optionality has allowed investors to gain. Now those are financial options and and the reality is protecting against the downside in the stock market is expensive.

It's why buffer etf, which offer this downside protection, do so by capping the upside. I recently invested in a buler etf by I shares M A X J. IT keeps the upside at ten percent, but protects against the downside.

I will use my optionality to move in to another etf if we get close to that upside cap. Now we talk about the volatility of options. Buffer etf is a great example.

We talked about this last week in our plus episode for our money further rest with plus community. These buffer etf use what are called european style option, which means they can only be exercised on one day when and the option matures. If the stock market fell before, then they can exercise the option. They have to wait until the last day.

And a member was asking, what, why do they use these european style option when american style option? But we're used to thinking of when we buy an S P five hundred option, we can exercise at any time and close out our position buff for etf, use these european and style options because the premium to protect against the downside is less, because they can only exercise the option once per year and because the premium is lower, IT means they can offer a higher cap. But as investors, we have the optionality to, like I said, to sell that butt for etf when it's close to the cap and then moving into a different part of etf has a higher cap and a higher floor.

That's what I plan to do in this experiment that i'm doing in my portfolio. Those are financial options. So we pay a premium, get an asean c payoff, can protect against the downside.

We can capture the upside. What's more interesting me is options outside of the financial markets. And I was looking for examples of that. The pro, I had a recent example we read at the grocery store, and maybe this isn't a great example, but he saw that there was a case of bananas for ten dollars.

The bananas were going bad, and SHE paid the ten dollars so he could freeze the box of bananas so that he could make banana bread in the future. In the way to think about this was the ten dollars or premium. What's the upside? Banana bread.

You can make a lot of banana bread is worth way more than the ten dollar paid. Now SHE has the right to make the banana bread because she's got the bananas. He is not obligated to, but he was said he felt done having bought IT.

This is like a month later. And he said, why? And SHE guys, well, he doesn't want the bananas to go bad on that he bought. Then there's a lot of bananas and even bananas and in a freezer can go bad over time.

Not a great example, but IT is an example of paying a small premium for the right, but not the obligation to do something in the future. Better example would be trial and air. This has something pointed out by, I see michoel tub in his book antifungal calibrates.

Any trial and air can be seen as an expression of an option. So as long as one is capable of identifying a favorable result in exploiting IT, that's where the rationality comes in. You're running a business.

We run a business, hear money for the rest of us. And as a camp, we're always trying things, seeing what works. And if something works, we're gona do IT again.

And if something doesn't work, we're not going to do IT were being rational when an option is in the money. Some things working, we have to exercise IT, but sometimes we're afraid or we don't do IT. Here's an example on the financial side.

Back in twenty twenty, I had bother, and twenty thousand thousand I bought, put options on bank loans on a bank land. E, T, S, bank loans are syndicated loans. They're not investment grade.

When the economy goes shower, typically the Price a bank loans falls. And so I was using this, put options on bank one E T, S. To protect against the downside of of my portfolio pandemic, hit the economy, slowed the Price of bank loans, fell the put options stored in Price.

And I didn't sell because I got greedy. And I thought, well, I think things are going to get worse and the central bank stepped in and made things Better. And so when I closed out my options position in june, I did not make as much as I would have in march.

And so one aspect of options is when they get in the money, often, it's Better to close out your position and exercise your option. Before we continue, let me pause and share some words from this week. Sponsors, what does the future hold for business? Ask nine experts and you will get tenters bull market bear market rates will rise or fall.

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Net sweet dot come slash David. In this process of trial and air, often times, it's tempting to just have someone tell us what to do. I saw this when I was an investment advice or an investment advisory business doing what we do.

Now business is complicated. It's difficult and there's always a temptation and somebody outside knows Better what's working in what we can do. Now we can get ideas and then try them out and maybe paid for those ideas.

But the reality is an outside consultant isn't going to know as much about our business. But because there's such uncertainty in many endeavors is always a temptation just for somebody else to tell us what to do, why consultants make so much money. And some of them are very good in helping walk through that decision process.

Sometimes, though, when an option is in the money, just like with my put option is difficult to commit, exercising that option IT might be a new job opportunity, were RAID to take the new job because we're not sure it's gona work out, we might fail or something else might come along. That's Better. About seven years ago, the pro and I were driving to colorado, and we were just entering wami and we picked up a hit hiker or something that we don't do very often, at least in the us.

But for whatever reason, the guy looks safe. We picked them up. The name was red. He's just been to california, to an encampment, kind of a hippy thing, and he had raised money to travel by working in, mcDonald said.

He was an interpret, but he was just out trying to get to meet more people. But the reality is he he didn't know what to do. He had so many options, but IT was afraid to commit. I ask, well, you thought about doing a blog podcast, writing about your travel experiences, and he said, i'm not good at committing, so I don't even want to start because I know I will give up. Now that's a little sad.

We we have to commit, we have to try things we can do, try or an air unless we actually try to do something to see how IT works out by committing, by exercising our options that can limit our choices in the short term. I can also bring some at a discipline we here design as book. The wisdom of finance refers to an academic, Michael Jackson, that studies how companies use debt or leverage in their business and fines that often times having that debt provides the motivation and the discipline to make sure that exercising the options they're moving forward in order to service the debt, the sire rights that this leverage temper used in life in a similar way, not by necessarily taking out dead, although we could.

But he pointed that often times we know what the right thing to do is, and we might even agree that we should do IT, but for a number reasons, we don't actually take the action, might be exercising, not smoking, or spending time more time with our kids. And he says, by making a commitment, sometimes, sometimes there could be a financial commitment. Maybe it's a bet with friends, though I wouldn't want to bet with my friends that i'm going to spend more time with my kids, but maybe it's losing waiter running marathon or haps is a costly membership to a health club.

Maybe making that financial commitment is large enough to get us to actually go or some type of forced savings plan where IT happens automatically. There are some automation there or a commitment there that restricts our choices and increases our odds of success and of doing the right thing. Number years ago, I read a book by the economist Alice and trigger on risk and managing risk, and he said, the first thing to do to manage risk is to define what IT is that we want.

And then once we know what we want, we can look for risk free. The ways to get that options that limit the downside and capture the upside of what we want. SHE rides, taking a risk without a goal is just like getting in a car and driving around aimlessly, expecting to wind up in a great place.

You might land somewhere wonderful, but adds are you end up summer, you don't want to be IT sounds simple, but knowing what you want might be the hardest part of risk management. The pro I are doing that right now were trying to define what IT is we want. I don't have a job where I have to be at a specific place.

We are not geographically constrained, which means we can live anywhere. And we have exercised that optionality over the past decade, partly because we'd like to explore new places, but also lie likes to remodel houses. And so we bought houses.

We've remodel them. We've sold them. We ve bought another one. And four years ago, we bought a house. In two thousand, we remodeled IT. Now we have a lot of money in this house and two sun, and we like to some. We have friends that we've committed to living there.

Over the past four years, we made a choice but now were assessing our optionality again, because we would like to travel more and the pro would like to redo another house. But we also like our current house and were afraid of missing out of selling that and moving away from friends. But it's an expensive house to Operate and we have a lot of equity in IT.

And so we've been debating going back in for seeking input. Should we sell, should we rent IT, what should we do ultimately, we're onna need to commit. Now there's there's some judgment call to deciding when is the right time to commit to make the choice.

I like to keep my options open, just waiting to we get more information, we have more insight, but we can do that. And definitely at some point, we have to make a choice. We have to do the same thing in in our business or are other endeavors socially.

At some point, we have to commit to somebody because that commitment can make us a Better person. One of the thing about something is once we exercise our options, that does close off some doors, but IT opens up others because we get more experience, more knowledge, we gain more skills, more insights. Those things give us the ability to recognize other options that we might not have had because of the path that we took.

We've definitely seen that in, in our business. We launched as a camp over a year ago, and we initially developed acid camp in order to replace the research services that we use for money for the rest of us, plus to be able to share the charge to have the data, and we use IT for that. What I didn't realize is how much I would learn about the stock market and now the bond market as we develop the tools that I wouldn't have learned otherwise, because I had access to Better data, earnings data on the stock market forecasts, earnings convexity data and yellow data, historical yell data and spread data on the bond mark.

And so having some tens of thousand dollars into development, that was the premium paid. But the upside benefit is certainly more knowledge and the ability to help more people and give them those same tools that they haven't had access to because research services charge thirty grand a year more for them, and we're charged in two hundred box exercising that option trial and air brings us more learning, brings us more understanding and opens up more doors, closes some doors, but eventually opens up more doors. Education is a type of option premium that gives us more opportunity, often outside the financial arena.

The premium for options is just a time, but by spending a time and using a rational to see what's working, we can do IT, but we have to stay in the game. We can't take on too much debt so that we're financially ruined. The key to options is indeed to protect against the downside, not to be massively exposed to the downside.

We want to be exposed to the massive potential on the upside. Or even if IT isn't massive on the upside, just having any upside potential upside can be incredibly rewarding. And the comfort of having the downside protection of seeing IT like an option, of structuring like an option can be comforting, give us piece of mind and make us less stressed so that we can continue to scan and look for options.

But ten years ago, I read a book called refuse to choose by barber. Sure, I gets IT with anti optionality. But I did point out that some of us are scanners. Our personalities are not one to commit to one thing for years we might commit and do need to commit for several years.

But and I would criticized little bit from my business partners at my old firm because I tended to want to move on and try different things because that we get bored. On the other hand, we need both. We need people that are are happy to do the same thing for decades, and others that are always trying to, things I tended have both.

I've done investing for decades now, been in finance for decades, but how I go about IT has changed. And then so I can keep the national level there. And who allows me to be a scanner but also committing and that we all have to find the right baLance as we look at the options that are around us.

That episode for ninety two. Thanks for listening. Asia camp is investing with clarity and control, making the stock market understandable and helping you turn uncertainty into opportunity.

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