Philip R. Davis is the founder of Phil’s Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders. Davis is a serial entrepreneur. He founded software company Accu-Title, a real estate title insurance software solution, and was president of the Delphi Consulting Corp., an M&A consulting firm. He was also the founder of Accu-Search, a property data corporation sold to DataTrace in 2004 and Personality Plus, a precursor to eHarmony. Phil is a former editor of a University of Massachusetts Amherst humor magazine and it shows in his colorful writing, along with specific stock option ideas.
I first got really interested in the whole concept of options trading back in the 1990s because the mathematician in me realized they were mispriced. It was fascinating to me how all these Wall Street guys would give you these senseless prices on options.
I’m sitting and thinking, “Okay, well, it’s going to go in this kind of range, it’s going to be this and the value of the company is this, and therefore, that’s the maximum price. You’re telling me that you want me to pay five times what this option would be worth?”
Then I realized I could sell them. I thought, “Really? You mean there’s idiots out there who are willing to pay this much money for an option?” Like IBM is at 150 and somebody’s willing to pay $10 for a $200 call. I own IBM. It’s zero risk to me. They’re going to just give me $10 and I’m doing nothing different in my life. If IBM does go to $200 for some crazy reason, if it goes up 30% in value, then I’m going to sell it to him for $200 and he’s going to pay me an extra $10.
There was zero downside to that trade to me if I owned IBM and I intended to continue to own it. During the time I owned IBM, if every year I sold an extra $10 worth, in 15 years I’ve collected 100% more on my stock in addition to the gains it has. If it gets called away, I just buy it back and do it again.
This is not a complicated strategy. So my first basic option strategy was to just sell calls against stuff I had, and then say, well, I was going to sell it anyway. How can this hurt me? Essentially, if you own stocks and you’re not selling options against them, you’re an idiot.
That’s what I teach people. Don’t be an idiot.
Be the house, not the gambler
Almost every option newsletter is run by an “option strategist.” I am not that. I am a fundamental trader. I say to myself, “Is this stock going to go below $20? Is it going to go below 10 times its earnings in a normal year?” It won’t because other investors are going to come in and buy it.
The problem is people don’t understand how to identify that. People say, “Oh, no, Phil, I don’t want to buy the stock for 30% less than the current price, and I don’t want to make 10% for doing nothing. That’s no fun. How can I risk my money instead?”
So why do people take on these unnecessary risks that cost them money? I often refer my readers to what I call the “Microwave Oven Theory of Behavior.”
In short, it goes like this: People love to make random decisions and stick to those decisions like they were commandments!
How does this relate to microwaves? This is what I observe: You put something in the microwave, say pizza, and you put in a time, say 3:33. Or maybe you are a whole number person and do three or four minutes.
Now, unless you are a chain-store pizza buyer, your pizza slice is probably not always the same size or maybe it has different toppings. But you probably put in the same number every time.
Theory No. 1: People tend to repeat behavior, especially if it was successful in the past.
So the light goes on and the little thing spins and you are either a watcher or a walker. (As you may have guessed, I hit the button and leave the room!) Either way you usually end up standing by the oven with 20 or 30 seconds to go waiting for it to stop.
Here’s where the Nobel Prize committee has to recognize me:
Theory No. 2: Everyone likes to think they knew something when they made that first choice of how long to heat the pizza.
You are standing there watching the pizza spin and looking at the timer. You may think it is done. You may know it is done. Perhaps you see cheese bubbling.
You may be hungry. You may be in a hurry. But you will wait and you will watch the numbers on the microwave oven count down until you hear that beep. Go on, try it. I challenge you to open the door with three seconds left.
Theory No. 3: People tend to stick with arbitrary prior decisions despite new information to the contrary.
You pick a random number of seconds to cook food and then, despite observations to the contrary or a change in the situation, you stick to your original decision. In fact, you are trapped by it! It is very, very hard to ignore your own advice, even though you didn’t intend it to be advice to your future self at the time, just a number you picked on a whim.
Your future self always defers to your past self because your future self thinks you are the greatest thing since sliced bread.
This is what happens to people just three minutes after a decision is made. What about trade decisions made days or weeks ago? You bet. We stick to the plan, however arbitrary it was in the moment.
It all goes back to trading.
Rather than rethink and reexamine our targets, we tend to treat them as being set in stone. Learning not to do this will make you a much better trader.
Old decisions were made by the old you. The new you has learned things since then, even if it was just three minutes ago. The new you is older and wiser and more experienced and has had the benefit of reviewing your past guesses — because that is all they were — in light of real world circumstances. The new you is ready to make a better decision.
Often the new me can’t imagine what the old me was thinking when I made a trade or set a target, but since I know and accept how often the old me makes mistakes I have no problem overriding my decisions, even if it means a complete reversal!
Focus on what you know
If you can do that you can beat the market, because 95% of the people you are trading against cannot let go of arbitrary targets they set for themselves when circumstances were different.
Here’s a trading example: If a stock is upgraded to $270 but it stutters at $255, sell! Open the door and take the pizza, it’s done! If it isn’t — you take a bite of your pizza and it’s still a bit cold — then put it back in.
That’s right, the old me bought at $230 last month when an analyst said $270 and the stock went to $255 in four weeks. I feel like a genius, so I start counting my $40 profit and thinking about what I will do with it.
The next week the stock flatlines between $240 and $250 and volume drops, but the old me said $270. I should have another $15 coming to me.
This is terrible logic! Why are you listening to the old you? You’ve had three weeks of observations, yet you are willing to ignore that in order to slavishly follow not even what you thought but what some analyst thought three weeks ago, when even he was listening to the old him.
You are you from the future. Full of knowledge that the old you wishes he had at the time.
Stick with me and Real Options Investor. I will teach you, issue by issue, how to ignore the old you and make better trade decisions. Over time, you will learn how to be the house and make money in every market environment, over and over.
As the saying goes, “Give a man a fish and you feed him for a day, but teach a man to fish and you feed him for a lifetime.” That is what we do. We teach you how to trade properly and give you valuable tools, such as options, to make you a better trader — for life!
I look forward to helping you get richer not only in cash but in knowledge about the markets, the world, and the crazy humans who make it all work, for better or worse.
I Want to Know What Phil Can Teach Me About Options!