From a US forum on Options, which applies to stock trading as well:
After a good trade, a trader concluded as follow:
I do not focus on trades, I focus on strategies. And this strategy is intent on capitalizing on a few items:
1) BEHAVIORALLY, as human beings we are not programmed to accept strategies like this one, with frequent small (if you do your money maanagement right) losses
and infrequent large gains. This behavioral bias = opportunity for those who
can control it.
2) LESSER followed stocks and options. I don't want to be playing in the same
pool as the institutions and I don't want intelligent eyes on the trade.
Liquidity + intelligence = efficiency. I don't want efficiency, I want
3) At EXPIRATION the models break down. There ｃ ｒｅａｔｅs huge opportunities,
because no one knows how to price the options.
4) A CATALYST that offers the potential to render the historical and implied
vol calculations irrelevant.
5) LEVERAGE is the most beautiful thing in the world. Positioned correctly, you
can lose many, many times and still make enormous profits because of the
leverage that options convey.
Comments from another Trader:
1) Assuming that a behavioral bias allows options to be mispriced. We all want
to think we are contrarians and that somehow we have found some secret advantage that the herd fails to see. The thing is that a professional somehow was not duped into selling you your hundred lot because of a behavioral bias/flaw. You
can spend years data mining and backtesting and developing complex algorithms
and when it comes to actually executing your order, its scooped up in a
nanosecond. Do you really think the pro on the other side of this trade
completely screwed up how it was priced?
2) Illiquidity does not mean inefficiency. It means greater risk and thus
whoever has to absorb the risk of making a market has to price in a premium to
compensate for that risk in trading with you. I can assure that unless you have
true insider info, everything you think you know, the market knows.
3) "(A)t expiration the models break down...no one knows how to price options"
Really? How many billions of trades have gone through expiration? Somehow no one
can get these right? But you've figured it out.
4) A "catalyst" i.e. a known event like an earnings release makes historical
and implied volatility irrelevant. I agree in part with this but for the reason
that ANY historical or implied volatility is irrelevant. If you trade based on
the past under any circumstances you are playing a fool's game.
5) Leverage is your friend. And it can be your worst enemy. Your real friend is
disciplined position size relative to your capital. Let's assume that Bernard's
strategy wins 25% of the time. Edge is not the issue here yet; its how much
capital is risked that may impact whether you can even trade enough times to
If you win 25% of the time that means you will lose 75% of the time. If you risk
$1000 each time it is really important that you balance that against your
overall capital. If you only have $5k (ie you risk 20% of your capital) you will
almost certainly go bust. In fact there is about a one in four chance you will
lose everything. If on the other hand you have $100,000 (ie you risk only 1% of
your capital) with the same strategy, your chance of going bust shift to about
one in three trillion. That gives you a lot of opportunity to see if your
strategy makes money.
Now consider edge. If the strategy wins $4k one time and loses $1k three times,
on average you make $0.33 for every dollar wagered. That's powerful, positive
edge. But what if you only win one in five times - now you have zero edge and no
chance of ever getting ahead regardless of position size.
So rather than leverage, the real concepts to grasp are position size and edge.
If you are disciplined with how much you risk and you find some way to eke out
any kind of edge over the long haul, just maybe you've found your way to make