The Game of Investing, Vol. 3
- Real Vision
- February 24, 2023
Welcome to The Game
The Game of Investing Newsletter…
…a bi-weekly newsletter where you learn from investing pros about how this game actually works.
Because learning about finance shouldn’t be boring.
This Week…
We’re back in the options game. If you missed Part 1 (we were never going to be able to cover options in just one issue), just search for “Imran Lakha” in your inbox.
Last week we covered:
- The Basics — from the various use cases for options to a contract’s relationship with the underlying asset.
- Premium pricing and how profiting from options comes down to understanding things like probabilities and time decay.
- How to read an options chain to better understand demand and how premiums move.
This week, let’s dig into exactly how Imran Lakha, founder of Options Insight, uses options in his own investing process.
Side note: You can watch an episode of Real Vision’s Daily Briefing with Imran for free right here.
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LEVEL 1 — An Expert’s View
As you’d expect from a former market-maker on the London Stock Exchange, Imran’s personal investment process is quite advanced.
Like anyone else, he holds a basket of assets in his long-term portfolio. But unlike many investors, Imran uses options to trade around those long-term holdings — earning income and hedging his positions along the way.
- If he’s long an asset, Imran will sell calls or with a strike price above the underlying, generating short-term income as long as the stock doesn’t surpass that strike.
- Conversely, he’ll use puts and spreads to hedge against any inevitable downturns for his holdings.
On a broader scale, options give Imran a clearer view of the entire market. Here’s how:
Imran constantly tracks options flow — a trading tool used to analyze institutional options activity. These are trades from highly sophisticated investors that can move markets.
- “[Options data] is a way of honing in on the sophisticated end of the market to get a read on what those players are doing, which can help guide your own thinking about the market,” says Imran.
- “You might be bullish or bearish. But if the options market is diverging from that and you’re seeing flows that reflect the opposite, it’s very useful to know that.”
Options can help gauge future risk… or lack thereof. Options data helps Imran notice shifts in sentiment and things like risk events that may be coming down the pike:
- “Then you can investigate and see what the market is anticipating, and there’ll be opportunities to trade options around that.”
Level 2 —Reading the Market
Imran reads options to understand overall market structure. With options data, Imran can track things like open interest, skew, and term structure.
- Open interest tells us what contracts are trading where. Over time, we see how these areas of demand lead to price discovery in the market.
- Skew relates to a supply and demand imbalance between options contracts. “Everyone needs protection, particularly in the equity market, so there tends to be a lot of demand for downside puts,” Imran explains. That dynamic raises the value of options far below the underlying price.
- Term structure is all about expiration dates, particularly how — and when — premiums of the same strike fluctuate depending on the date of expiry.
With all this in view, Imran can spot where market hedging has created particularly strong levels of support and resistance, where there might be demand that needs to be discovered, and when volatility is expected to pop up.
In other words, he can sort of see the future. And you can too — it just might take a while.
Next Time
In the next issue, we’ll be covering the psychology that drives markets and the science of building your own unique portfolio. See you there.
The Game of Investing Newsletter…
…a bi-weekly newsletter where you learn from investing pros about how this game actually works.
Because learning about finance shouldn’t be boring.
