Intelligent Option Investing consists of:
- Rationally assessing the value of a stock.
- Seeing clearly what the option market is forecasting for the stock’s price.
- Using a sensible combination of stocks, options, and cash to tilt the risk / reward odds in your favor when a stock’s value deviates from its price as forecast by the option market.
To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What?s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.
The sound intellectual framework laid out in The Framework Investing for analyzing only four fundamental valuation drivers allows you to rationally assess the value of a stock. The book’s discussion of and advice for sidestepping behavioral biases and structural impediments is meant to help you keep emotions from corroding your sound intellectual framework.
The first step of investing is understanding the value of the thing in which you are investing. Period.
Seeing Clearly What the Option Market is Forecasting
The option market projects the future value of a stock in a mechanistic way. It does not assess value (and certainly does not assess value rationally) but instead, it projects future prices.
Understanding what the option market is saying is like playing cards with an opponent who keeps each hand face up on the table.
All an intelligent investor must do is compare his or her rationally assessed value of the stock with the mechanically predicted price of the stock shown by the option market. When the discrepancy is large, there is a chance to invest.
Tilting the Odds in Your Favor Using a Sensible Combination of Stocks and Options
Through the two steps above, the intelligent option investor has a great advantage over the rest of the market. Naturally, the intelligent option investor chooses to invest in only the most attractive opportunities and this, in itself, tilts the odds in his or her favor.
Most option strategies are levered ones and leverage is dangerous if one cannot measure and manage it correctly. Managing leverage sensibly allows you to further tilt the odds in your favor.
The great Chinese strategist Sun Tzu said that a good general won by putting himself beyond the possibility of defeat. This concept is the essence of the third step of intelligent option investing.