Excerpt:

I have been writing often lately about using optionality to minimize risks while catching all the upside. It is my favorite strategy – buying options.

For me, as I learned from Nassim Taleb, out-of-the-money options are my way of experimenting in the markets. I can tinker with small amounts of money upfront that will either a) expire worthless, or b) make me a significant profit. This trial and error allows me to see what works and what doesn’t without causing me harm.

Personally, I would rather lose small amounts of money 9/10 times and then have a nice 10x (1,000%) bagger. Instead of making small weekly gains 9/10 times only to lose them all suddenly if something goes wrong – to “blow up“.

But I have been getting many comments claiming that buying options is only gambling. Pure luck. And not worth the time or upfront money paid out in premiums to buy them.

While there is definitely a randomness and luck factor involved, I think speculators can use the business cycle towards making more attractive educated guesses.

My strategy for optionality in the markets depends on the cycle. You always have to ask yourself:

“Where are we in the cycle? What is more likely to happen next?”

For instance, take a look at the graph I made for my thesis:

Using the business cycle as a primer for the strategy, I look to take advantage of the market sentiment and the extremes, i.e. from peaks to bottoms.

What I mean is when the market is peaking and has “boomed” for the last couple of years, PUT options will be the cheapest.

For instance, if you haven’t had a tornado in a while and the weather has been great in recent memory, you feel a false sense of security and don’t renew your tornado insurance. Therefore, writers of insurance will lower their prices as demand has fallen.

I wouldn’t want to buy put options right after a crisis, like 2008 for example. That is when the market is pricing them highly. Why would I want to buy tornado insurance while I’m watching my house get lifted away by the tornado in front of me? It is too late at this point, and my insurer will charge me significantly more.

When the market is bottomed, or has been in a bear market, I think it is wise to load up on long-dated out-of-the-money call options. Therefore, when the market eventually rises, those calls will catch all that upside. And if they expire? No problem, I will buy 1-2 years more again for pennies.

As a case study for put options, let’s look at the most recent boom and bust in the oil/gas market. . .

Read the Call & Put Strategy Case Studies and the Rest Here