Las Vegas Can Teach You a Lot About Trading Risk

Jon Lewis

I spent three days in Las Vegas, which is about all I can stand (the other seven days were in Arizona).

If you take a step back and peer through the free-drink fog, Vegas can tell you a lot about how you relate to risk.

Of course, we all know that Las Vegas (and I mean casinos and everything else) exists to separate you from your money in whatever way possible.

Understanding that, my goal is to enjoy myself without getting gutted. And that means avoiding much of what Vegas offers.

But let’s get down to risk.

I like to know what the risk and reward are.

Slot Machines Are Pure Gambling

Slot machines are pure gambling, because you have no idea what the risk and payouts are.

Frankly, I don’t know what’s good or bad with these things. You press the “how many credits” button and let it whirl. Usually nothing happens and you press the button again, watching your balance decline. Or, if you “win,” you see some credits add up, but often they don’t even match the original bet. And you have no idea why you “won” in the first place.


Playing Craps Is Defined Risk

Because I want to define risk, my game is craps.

I see the dice, I throw the dice and I know (assuming Danny Ocean and crew aren’t around) the odds of each number coming up. I also know that the best odds in the house are backing up pass and come bets with odds (don’t worry if you don’t understand craps). Yes, the house has a small advantage on the initial pass or come bet. But after that, odds are paid at even money.

That means if I back up a six or eight, I will get paid six to five on my bet.


Because there are five ways a six or eight can come up (you win) and six ways a seven can come up (you lose).

If I back up a five or nine, I get paid true odds at three to two (four ways to win versus six ways to lose). And four and 10 get paid two to one (three ways versus six ways).

I avoid all the other bets on the table because the house advantage is too large. I’m not getting paid for the risk.

I enjoy the action, the other players are usually great to watch and I know I have about an equal chance to win or lose. In Las Vegas, you can’t do any better than that.


Gambling and Trading

So how does that apply to how I trade?

Again, it’s all about risk and reward.

I close trades early because the risk of having the position move sharply against me over the next week or two is not worth the reward of the few pennies of credit I’ll get if the spread expires worthless.

I know that options are historically overpriced. That is, the volatility inherent in the premium is usually greater than the subsequent move.

Thus, I’d rather be a net seller of that overpriced premium rather than a buyer because it puts the odds more in my favor.

I prefer to sell premium when implied volatility (IV) is relatively high, because I know that IV is mean reverting. If it’s high, there’s a better chance it will fall and pull premium from my spread.

Does it always happen that way?

Of course not. But again, all I’m doing is trying to tilt the odds my way as much as I can.


Stock Market Moves are Random

And, perhaps most controversially, I assume that stock and market moves are random in the short term.

We are short-term traders, not Warren Buffett. We’re not buy-and-holders, at least not with Smart Options Income.

We don’t have some scheme to divine a stock’s short-term move. That’s why we try to stay neutral by playing bullish and bearish spreads.

That said, a credit spread is a marginally directional strategy. Thus, there must be a decision point as to direction.

So, I’ll look at points of support or resistance on a chart, moving averages and whether a stock is technically overbought or oversold. But I still assume that movement is likely to be random.

That’s why I use out-of-the-money credit spreads, which give me room to be wrong on direction (which often happens).


Protection Against Randomness

To further protect against randomness, we try to stay neutral in the portfolio.

This is just another way of dealing with the risk of sharp market moves. It’s also a way of me acknowledging that I have no idea where the market is headed.

Just like I know I have no idea what number is coming up on the dice.

(True story. There was a guy standing next to me at the craps table writing down each number that came up. Why? I suppose he figured he could somehow discern some pattern or discrepancy in how the numbers came up and then use that to his advantage. It baffles me how some people think.)


The Bottom Line

The bottom line is that I approach trading and gambling the same way.

I understand the odds, risks and rewards.

And I try to manipulate them to put them in my favor. But I also know that I’m not smarter than anyone else.

I don’t have some secret formula.

And I know there is no get-rich-quick scheme. I stay disciplined and stick to the system.

No prop bets for me in Las Vegas for me.


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About The Author

Meet Jon Lewis, With over 20 years of real experience, teaching AND trading, Jon will help you learn to use options profitably and safely in portfolios of any size.

His advantage, and now yours, is using simple, often overlooked spread options strategies which generate consistent income without significant risk.