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I am often amazed by the lack of common sense when it comes to investing.
Investors seek the best possible information, but unfortunately most turn to the wrong sources.
For starters, turning on the television for investment advice, in most cases, is a big no no. Yet, how many people listen intently to the daily drivel coming out of screaming mouths on CNBC? Investors, particularly traders, should know that every trade spouted from these sources has a 50% chance of success. Add in transaction costs and the probability declines further. Yet, the majority of investors and traders take this approach, mostly because they are not privy to any other form of investing. Self-directed investors are not aware that there are strategies based purely on probabilities, not gut-driven analysis.
For instance, take a look at the year-end S&P 500 targets for Wall Street’s top strategists.
JP Morgan’s Chief Equity Strategist Tom Lee has been adamant about the investment banks price target of $2,075 for the S&P 500 by year end.
What does the option market say about the probability of his stance?
If you look at the monthly call options for the January 2015 expiration cycle you can see that there is only a 19.03% probability of SPY hitting $2075 on the S&P 500. Those are not good odds.
Why would anyone make a directional play with a 10-20% chance of success? It doesn’t make sense. And why would JP Morgan come out with such an outlandish call?
I wish they would say something like, I think the S&P 500 is going to 2075 by the end of 2014, but there is only a 20% chance that it will happen. You would never hear that stated publicly and I think we all know the reason why.
You see, I don’t really care about the opinions of others when it comes to the market. You shouldn’t either. Next time you hear a talking head say that Apple is going to $1000 or down to $250 take a look at the options market. You will be surprised what the probability is on each and every stated guess.
Fortunately, as an options trader I can use these same probabilities to my advantage.
Rather than buy a call or put with less than a 50% chance of success, I can sell out-of-the-money credit spreads with a high probability of success, typically over 80%. This puts the odds in my favor.
Just think if you went to a casino and they had a game on the floor with an 80%+ chance of success. Well, that is exactly what is happening in the options market, but for some reason individual investors haven’t caught on to statistically-based investing.
Many investors new to probability-based investing complain about the risk/reward of an out-of-the-money credit spread. They don’t understand statistics. But for some reason they understand the voodoo logic spouted by the major financial media outlets.
If you would like to learn how I invest based purely on statistics you can sign-up for my free weekly newsletter The Strike Price.
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