Call Options Are Like Lottery TicketsThe Acquirer's Multiple
During his recent interview on The Acquirers Podcast with Tobias, William L Silber, author of The Power of Nothing To Lose discussed Call Options Are Like Lottery Tickets. Here’s an excerpt from the interview:
Call Options Are Like Lottery Tickets
Tobias: You see this manifest in the real world as well. You give the example of investors who ordinarily would hold some cash, hold some stocks. We’ve seen this behavior more recently with the expansion of Robinhood and a lot of new entrants into the market perhaps because people are bored and locked at home with COVID last year, but there’s been this explosion in the use of options in investing, and you say that the option, the call option payoff in particular has that characteristic that you’re discussing. Perhaps, you could just elaborate on that a little?
William: Sure. That’s my favorite example and you certainly did your homework, Toby. All right. What I say is that a call option is precisely a security which gives you big upside. The higher the stock price goes up, the more you make continuously, continues to go up. If the stock price goes down, well, you do nothing and you lose what we call the option premium. It’s called an option premium, it’s really the price of the option. So, the payoff to every call option is skewed. Big upside, limited downside. In fact, that’s when you buy a call when you are, ready, worried about downside protection. That’s what a call gives you. That’s why calls on the riskiest stocks cost the most. Why is that?
If they were free– I give you a choice between 10 different call options and they’re all free. Which do you choose? Well, the one that has the biggest upside. I want the option on bitcoin. I don’t want the option on the S&P 500. It’s too boring. So, call options gives you big upside and limited downside. That’s precisely why meme stock players in recent months have bought out of the money call options, because they have skewed upside potential and very limited downside, and it could be a game changer, a life changer like winning the lottery.
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Article by The Acquirer's Multiple