Robert Leonard  02:00

Why would you say you’re a lousy trader or investor?

Tom Sosnoff  02:03

I’m a good trader. I’ve been trading for 40 years. So I’m a survivor. I’m definitely passed that test. I said I’m a lousy investor. I’m not a good passive investor. I’m not a good judge of, I guess, investments. I can’t focus that well on that kind of stuff. So I have a soft spot in my heart because when I first got started, people gave me money to trade with and, and bet on me. So I bet on a lot of people.

Robert Leonard  02:27

You can’t sit back and let you know, let it passively grow, you have to be actively trading?

Tom Sosnoff  02:32

Of course, 100%.

Robert Leonard  02:34

Has there been anything in your entrepreneurial journey that has impacted how you trade options and just any other types of instruments that you trade?

Tom Sosnoff  02:42

I’m definitely partial to two very short-term active instruments. I don’t trade a lot of stocks. I trade mostly all options and futures and options on futures, really any kind of alternative investment, I have a shorter-term timeframe. I guess if there’s a financial instrument that I like, it’s something that has a shorter lifetime.

Robert Leonard  03:08

The majority of the audience that’s listening today are young investors, or are just relatively new investors. Some have a little bit of experience with options and have heard previous episodes that we’ve talked about it, and others are completely new, they’ve never heard of options. So before we get into a deep discussion about options trading, I wanted to find some key terms that I think are going to be important for everyone listening to understand so that they can really get the most value from today’s episode. So could you define for us what options are the different types, puts calls and how they all work?

Tom Sosnoff  03:39

I’m a really bad Options 101 teacher, and you think I’d be good at this because I do it all the time. And the funny thing about the whole financial space is when I got into the business, the only reason I got into the world of finance, is I was really studying international government and politics and things like that. When I was in school, I never studied finance. The only reason I got into finance was because it was the middle of a recession. It was the only job interview I got, and they offered me a job.

So I took it at a big investment banking firm, Drexel Burnham at the time. They’re out of business now, but at the time, they were one of the biggest boutique firms in America. They offered me a job and I just took it and I’ve stayed in the business ever since. But I got involved in options right away because I was like, What are these things? They caught my attention and here’s the reason. So most financial instruments and this goes to all of your listeners. Most financial instruments are what we call static; they’re very black and white.

So for example, if you want to buy a piece of real estate, you know you buy it and all you hope for is it goes higher. If you want to buy a stock, you can go long or short it but you’re hoping it either goes higher or lower. That’s a static trade. It’s purely black or white. If you buy or sell a commodity or a future like gold or Bitcoin, essentially you’re hoping it goes higher if you buy it, hoping it goes lower if you sell it. But those are static, they’re not strategic.

The world of options is gray; it’s not black, it’s not white, it’s totally gray. You can be wrong and make money and you can be right and lose money. So it’s a strategic marketplace that is very liquid and very efficient and a lot more fun. Because there is a lot more stuff you can do. So if you think of yourself as a strategist, or better yet, if you think of yourself as somebody that’s really good with numbers, you love math, or you love probabilities, or you love statistics, then you’ll like a financial derivative product like options.

That’s why I got into that space, and I didn’t even understand all this when I first did. Now, the marketplace has come a long way to where we are today. That’s why firms that people listening might recognize like Robinhood, and places like that 70% of their business is now options. 70% of their revenue, 80% of their revenue is options. It’s not stocks.

Robert Leonard  05:53

What are some of the important terms or concepts that somebody needs to know when it comes to options traders, if they’re completely new, if they’re just entering their hearing this they want to get invested. What are some of the things that they should study and learn first?

Tom Sosnoff  06:05

So options have a price dependency on what we call implied volatility. Implied volatility is another word for expected range. So if something has an implied volatility of x, that means it has an expected range of x. It’s just a math formula. It’s just a Black Scholes, you know, mathematical model. So what options do is they price themselves off of fear and opportunity. That’s the simplest way to understand options. You have to appreciate an option’s sensitivity to volatility if you’re going to be strategic about it.

I think what a lot of people don’t realize about options is, they were designed to give you leverage, risk a little make a lot. But there’s lots of ways to play options, and futures and futures options and everything else, where you can potentially risk a lot to make a little. If you’re thinking, why would I ever risk a lot to make a little as opposed to risk a little to make a lot? The answer is because the probabilistic model is all symmetrical. I’m giving you a little bit of a high level discussion. But the reason for it is anybody can give you a definition of a put or call or a call spread or a put spread. But when you really want to understand strategic investing, if you limit your profitability, you increase your probability of success. And that’s one of the things that we love about options and all derivatives is that you have an opportunity to be a) capital-efficient, and b) to potentially limit your profitability for a higher probability of success, or accept a lower probability of success for unlimited profitability. It’s your call.

That’s of the really cool things that you can’t do with any other financial instruments. The next piece is, in the world of stock trading right now, when you think about it, is you have a lot of millennial investors. Let’s say some investor says, You know what, I’m really interested in Tesla. Well, Tesla’s a $740 stock. So 100 shares of Tesla, okay is $74,000. Most millennial investors don’t have $74,000 to buy 100 shares of stock with. So what are you going to buy, you’re gonna buy one share for $740, or a fractional share that you can’t do anything about? That’s not interesting to me.

But for $200, you can sell a put spread and get long Tesla. Or for $100, you can buy a call spread, meaning that, you know, if Tesla goes up, you profit, and you’ll make more money than you would have made if you bought one share of stock. So there’s lots of ways to participate in a capital efficient world in a in a time when there’s very little capital efficiency in the financial markets, because they’re so expensive.

Stocks have priced themselves out of the millennial price range. I mean, Amazon is a $230/$300 stock. Even when you kind of look down the list of the most active stocks, I mean, Tesla is $735 on the close today, Netflix is $520, Google is $1740. Facebook is $270. To buy 100 shares of Facebook is $27,000. That prices, most small investors and most millennials out of the 100-share stock marketplace, which is a round lot. It limits all the different strategies you can use. The option marketplace opens it all back up to you. And that’s what’s cool about it.

Robert Leonard  09:27

Yeah, the same could be said for two other companies that I really like. Mercado Libre and Shopify, they’re both over $1,000 a share. There’s nothing a millennial can do with those.

Tom Sosnoff  09:35

There’s nothing you can do in Shopify. That’s the problem. But if you have $200 to risk, you can do a five point wide iron condor and play the stock will land in the middle or you can sell a put spread and hope the stock goes higher, or sell a $5 wide call spread for $250 and risk $250 you know and hope the stock goes goes down. There’s all these different things you can do as a strategist that are super cool that you can’t do as a passive investor.

Robert Leonard  10:04

When does somebody get started with these? If somebody’s new to the markets, is it good for them to just jump right into options? Or should they have some experience with stocks first?

Tom Sosnoff 10:12

One of the biggest misconceptions about finance is that you need this ridiculous level of experience, or you would have played the markets for some time. Yeah, there’s a little bit of terminology. I mean, if you can figure out how fantasy football works, you can figure it out. We own Tasty Works, which is our trading platform. It’s high-frequency-based middleware. It’s front end technology that blows away any gambling app or anything else that’s ever been built for trading. You can learn that in two seconds. It’s super simple. You can trade any product that’s complete product and different.

The reason I bring this up is because anybody that can figure how to use an iPhone can figure out how to trade on all these platforms in a few seconds. And that opens up virtually every strategy at every financial product with no restrictions instantaneously. Hhere’s the beauty of it. Where else can you build up risk-taking skills and decision making skills? Where’s a better place in the financial markets, which are incredibly efficient? I mean, that’s the coolest thing. How old are you?

Robert Leonard  11:16

25.

Tom Sosnoff  11:17

So at 25, you don’t have a lot of opportunity, unless you’re trading to make financial decisions and have a monetary outcome that can feel good or hurt you and emotional decisions that lead to a monetary income or some kind of some kind of outcome, where speed of decision making, all of those come into play. Where your brain processing speed is the motivation along with testing yourself, strategy-wise. You have no other opportunity, nobody does. You can’t trade anything else to do to make that happen. But in the world of trading, active universe, you can do all that. And you can do all of it with a few thousand dollars. And you can change the outcome of everything else you do for the rest of your life.

Robert Leonard  11:59

What strategies do new options traders start with? You mentioned four or five, six of them. They’re maybe not the most complex, but a lot of people that are new to options, probably haven’t heard of them. So what type of strategy do they start with?

Tom Sosnoff  12:11

I’ll get that to one second, I’ll just give you this little second background. So you asked me earlier how I got started in this business, I told you, it was the only job offer I got. And when I first started working for this financial firm and trading options, I had no idea what they were. All I know is I made more trades in my first six months than any other person working at this firm. I didn’t make any money, I didn’t lose any money. I just broke even after six months, but I made like 650 trades. So they called me into some manager when I was 23 years old, some manager called me in and said, hey, you’ve made more trades than every other employee in this firm combined, what was going on with you? I’m like, I don’t know, I just really liked it. It’s kind of fun.

I didn’t make any money. But I learned so much. from doing that. I learned 100 times what I learned working at this firm, which I learned nothing. I learned so much from making those trades that it changed the trajectory of my whole life. That’s how you become an entrepreneur. That’s how you become whatever it is that you decide to ultimately do. So I argue that that’s the beauty of, of active trading and being aggressive in the marketplace. But what strategies does somebody do for the first time? Well, if you’re bullish, you can sell an out of the money put one lot.

If you’re bullish, you can sell an out of the money call spread. If you’re bullish, (meaning you think stocks gonna go higher), you can buy stock and sell a call to a covered call on an inexpensive stock. But selling a put is a little more capital-efficient. If you’re bearish, you can sell a call spread, you can sell a call, or you can buy a put spread. There’s all these things that are very inexpensive to do, and a few hundred dollars, they teach you everything about strategy, about decision making, about risk assessment. Once you short something, the way you look at the markets is forever changed. If you only buy stuff, you have no perspective on what a two sided market is. If you sell stuff as well as buy stuff, you can think about things much more objectively, and much more subjectively.

Robert Leonard  14:12

Why did they call you in their office? Why did they care how many trades you had? I’m curious?

Tom Sosnoff  14:18

They were paying me to work. They wanted to say, Hey, you know what, there’s something wrong with you. But back then people didn’t make that many trades. I went from that job straight to the trading floor on the CBOE. And I quit there after six months and moved to Chicago and went on the floor of the CBOE to trade. I promise you I’ve never been West to the East River before. So you’re on the east coast. I grew up outside of New York and I’d never been West. I just went to Chicago and started trading and stayed there for the next 40 years.

Robert Leonard  14:47

I want to talk about selling naked puts because it’s a strategy that I use. I wouldn’t necessarily classify myself as an options trader. I do make trades from time to time. Typically it’s like one or two times a month. I’m not trading every day or even every few days. But one of my favorite strategies is selling naked puts. And pretty conservatively. I look at 100-day historical volatility and use three standard deviations typically, to calculate the probability that a stock will trade within the given price, and then allowing that stock option to expire worthless, so that the buyer expires worthless for the buyer and I keep the premium as the seller. I typically only make this trade if the stock has a likelihood of staying above that price of 70% to 75%. And that, of course, limits my returns and the premium I can collect. But for me, I like this conservative approach. What do you think I might be missing about this strategy? And why might it be a bad strategy?

Tom Sosnoff  15:37

First of all, it’s not a bad strategy at all. It’s what we call a high probability strategy. And it’s not a bad strategy. In fact, if you go back through the history of the stock market, it is the most effective, most capital efficient, most effective, highest probability strategy there is. There’s a saying in this business that “puts are schmutz.” Essentially, what you’re doing is probably assuming that you’re bullish, what you’re doing has the highest probability of success. We trade the exact same way. We have probably a tighter set of mechanics than you.

We’ll go to a specific delta, because we know that the options are all priced off volatility anyway. So we’ll go to a specific delta, we usually go about 45 days out our optimal sweet spot. And for a lot of reasons it has, we’re out of the money options fallen decay curve, the sweet spot is about 45 days out. The sweet spot is about around the 20 delta strike, which means there’s an 80% chance they don’t get to that number. Ideally, you don’t want to hold those to expiration, ideally, you want to cover about 21 days, and that’s it left till expiration, to sell the 45 days cover 21 days selling to high implied volatility. And that is your highest probability trade. So you’re not doing anything wrong at all. You’re doing it right.

Robert Leonard  16:51

What I like about it is that it’s not you’re not really risking the farm, if you will. I see a lot of millennials that are trading these super lottery-type pick options. And that just to me isn’t like a sound or viable strategy. To me, this is like a pretty high cashflow, conservative strategy.

Tom Sosnoff  17:07

Well, the difference is that it worked very effectively buying a lot of cheap options in a stock like Tesla, or buying a lot of cheap options in a stock like Zoom last year, and there was a bunch of other Evie stocks and things like that. People got paid, and they got lucky. It’s almost like last year was a little bit of one of those lotto years. And so you get romanced. It’s sexy to get paid 10 times on what your risk is.

I have a story I tell. It’s my first option trade ever. I was 23 years old. And I bought to a lot of puts in a stock called McDermott, which is no longer as an oil service stock, which is no longer in existence. I remember, I made millions of trades. I remember almost all scary. But I bought a lot of puts in McDermott, and I paid $300 for each one $3 apiece. And a couple days later, the stock dropped. And I sold them at $420. So after commissions and everything else I made about $200 on my two lots. Bought them at $3 sold them at $4, I made $200 after commissions.

I lived with nine guys, we had a giant house. And we were just out of college. And I went back into the house and I told all my buddies and I’m like, I freaking got this. I found something none you guys have ever even heard of before, we’re gonna make a fortune. None of us had any money. So we’re this world, we were on our first job. So I got everybody to pool together all their money, we put a couple of 1000 bucks together. And I took it and I started trading options. In two weeks, I lost every penny and nobody talked to me for a month. These are my best friends since we were five years old.

I couldn’t believe what an idiot I was. And I thought at the time, like I discovered, I really thought I found God type of thing. I realized two weeks later, I was beyond clueless. That’s what motivated me to you know, learn this space. There is no free money. And all there is is math equation that works. We play a game called law of large numbers. That’s all it is. And if you do things with a high probabilistic outcome, eventually if you do it enough times, it’s going to work. That’s the simplest way I can explain how I’ve learned to adapt to this business over the last 20 years.

Robert Leonard  19:22

What was the strategy that you implemented that lost at all? What was the mistake you made?

Tom Sosnoff  19:27

Oh, back then I have no idea. Probably just bought options. I have no idea. I mean, I didn’t have enough money to do anything but buy options. But my trading has changed. I’m still a junkie. I mean, I trade 75 to 125 times a day. And I’m a retail customer just like you or anybody else. I trade probably close to 15,000 trades a year, right now as a retail customer and as the CEO of our company, so I have a full-time job too. And I trade everything: futures, options on futures, stocks, stock options, indexes ETFs, I don’t care what it is I’m product indifferent.

Robert Leonard  20:04

When we talked about the naked puts you mentioned that you don’t typically hold till expiration. Is that because data and research has shown that it’s not the optimal strategy?

Tom Sosnoff  20:12

That’s correct. The fastest point of the decay curve, for out of the money options is between day 45 and day 21. That is when you make the most money with the least amount of what we call the standard deviation, but it’s really the least amount of risk. It’s the variability of the standard deviation, its risks. So you have the most potential with the least risk from 45 days to 21 days. Inside of 21 days, what happens is, there’s what we call gamma risk. That’s basically another word for saying, How fast can this position bite you in the ass, and that’s called gamma risk. That’s when the gamma risk kicks in, and like the last two weeks of every expiration cycle. So you take the least amount of risk in a longer period of time and the most risk in the shortest period of time. And that’s how options basically break down. So yeah, the answer to your question is yes.

Robert Leonard  20:59

Is it also a proponent of taking money off the table, because if you’ve made a trade and you’ve made, I don’t know, if, say, you’ve collected 80% of the premium in the first, would you say 45, to 21. 24 days, then maybe you could catch another 20% of the premium, but maybe you’ve already collected 80%, you just take that off the table before you lose that?

Tom Sosnoff  21:17

You are correct. And it’s not 80%. If you can get to a  50% number, then you take it. So the answer is like you like to sell puts, let’s say you sell put for $1, if you can get to 50%, or 50 cents, in the first 24 days, you take it. That’s mathematically optimal. We own Tastytrade, which is the largest Digital Network now in the world for finance. And then Tastytrade owns Tastyworks and a couple of other companies too. We own a digital asset company, we own a magazine, we own another brokerage firm, called Dough that competes with the free ones, we have an advisory, we have lots of different companies. But our primary business, or my primary job is to provide financial content. And in that we have, it’s all free. Our archives have literally thousands or tens of thousands of hours of mathematical concepts. We don’t do any fundamental or technical analysis, we are anti-fundamental anti-technical analysis. All we do is math and quantitative analysis. Is this research statistically significant? And does it meet the math test? If that is the case, then we put it out there. We’re a think tank.

Robert Leonard  22:27

That’s something that I’m gonna have to take from this episode and implement to my portfolio because for the most part, I’ve let them just go to expiration. And typically, it hasn’t really bitten me yet. There was one time where it did, I think I had already gotten maybe 90 to 95% of the premium, but I was waiting for that last 10, five, five to 10%. And then it went against me, and I ended up having to buy the underlying shares. But this is going to be I think this is gonna be a good implementation for my strategy.

Tom Sosnoff  22:53

We have great research on this, Robert, it’s awesome. And you can see all the numbers will play it out for you. It’s amazing, just to give you a ballpark, you take almost 300% more risk in those last three weeks than you take in the first three and a half weeks.

Robert Leonard  23:11

And so when you sell you just buy the next one that’s 45 days out, what if you’re doing it at 30 days, do you not recommend buying 30 days?

Tom Sosnoff  23:18

That’s fine, because you can’t always do 45 days. You should just do closest to.

Robert Leonard  23:22

Still it stays at that 21 days?

Tom Sosnoff  23:25

Absolutely. The technology today is so good. And it’s so cheap. Trading is basically free. I mean, it’s just a hair over free. You can’t afford free. If you’re on a free app, that’s a mistake, because they’re not good enough. You need better technology; you need really intelligent technology. Like we say you can’t afford free. You need something that’s beautifully designed, intelligent technology that can apply strategic logic to it. In those examples, man, it’s so good you can roll stuff forward, you can do it all with a single click. You can take your front month position roll to another back month, you can buy in your front month, you can diagonalize it and go to the back month, you can do anything you want nowadays. You can change your quantities, you can do it all with a single click. Piece of cake.

Robert Leonard  24:10

Other than Tastytrade, which I would recommend people go to, other than that one. What are some other platforms that do well?

Tom Sosnoff  24:16

The best platform in the industry for the last decade or so has been a platform called Thinkorswim. I built that. Our team at Tasty built Thinkorswim. We started, we were floor traders. We left the floor in 1999 and 2000. We built thinkorswim from scratch, and we became a public company. We were bought out in 2009 by TD Ameritrade and we left in 2011 to start Tastytrade. And then in 2017 we launched Tastyworks with the same team that basically built Thinkorswim back in 2000. So we built a better mousetrap is what essentially what it is. So now we have the fastest-growing brokerage platform in America next to you know, behind Robinhood. But we’re very a different type of platform. We’re an intense piece of software.

Robert Leonard  25:05

We’ve talked about selling on the upside of puts,  if it’s going the way that you want it to, but what if it goes against you? Does research show that there’s a point where you should say this trade is going against me, it’s not coming back, I should just cut my losses?

Tom Sosnoff  25:17

When you sell something, we will go back to your example originally. Let’s say you sell a put, and you sell with an 80% probability of success. So that means you’re selling a 20 delta put, our research suggests that if that put goes to, let’s say, 40 deltas, it doubles in delta. So you have a losing trade on right now. At that point, you should do something. So there’s a couple of choices of what you can do. The first thing you can do is because you’re short of put, you can sell a call against for no additional capital, you’re already short a put. So you can turn around and sell out of the money call. Let’s say you’re short of 40 delta put in the example of selling originally selling a 20 Delta put, it becomes a 40. Delta put, now you’re down money.

So what can you do? For no additional capital, you could sell 20 Delta call and reduce the risk in your position, theoretically, by half, that’s one thing. Or you can buy back your 40 Delta put and move it out a month. So in other words, let’s say right, now you’re trading January, you can move it out to February. And then you can move your 40 delta to 30 Delta for a small credit, and that’s your second choice. third choice would be to reduce your size. And then the fourth choice, obviously, is you can cover the position or buy another option against it. But that would be our last choice.

Robert Leonard  26:30

Is there one of those three things that’s most optimal?

Tom Sosnoff  26:33

Optimal selling the call.

Robert Leonard  26:35

And how does that work tactically? Can you give us an example? It could be a fake stock, but give us some numbers of a stock.

Tom Sosnoff  26:41

So take a stock like XYZ. And let’s say you sold a put for $1.  Now all of a sudden, the stock started to go down, so you’re wrong. The put that you sold for $1 is $2. So now you’re short a $2 put and now you’re nervous, because the velocity of risk is always to the downside in stocks. So now you’re saying, well, I got to do something here, it’s totally reasonable. So you look at the calls and you go, I’m going to sell a $1 call. That $1 call is going to offset half the risk of that $2 put, at least theoretically. You put up no additional capital to do that. That is the first thing you do.

The second thing you do is you don’t want to sell the call, because that makes you nervous about getting whipsawed or something, you buy back that, that $2, put in the front month, and you sell a $2 or $2.50 put the next month out. But that’ll be a lower strike puts, you’re actually reducing your risk, because you’re giving the giving the trade more time. That’s how options work, you pay for time. That would be the second thing. And then the third thing is you can either buy another put further out of the money or reduce the size of your position or close it altogether.

Robert Leonard  27:53

How do you go about calculating your returns on this selling a naked put strategy? Do you divide the premium that you’ve received by the amount of money that you had at risk? Or do you just look at how much premium you collect throughout the year?

Tom Sosnoff  28:06

If you’re asking how do we figure out return on capital, we don’t look at trades on a return on capital basis, because we think it’s really misleading. In other words,  you can kind of cherry pick return on capital, without getting too granular on this, you can make return on capital, look, whatever you want it to look like. But if you were doing in the pure sense, you’d say, Oh, I sold this put for $1. And I put up $500 to do it. So my return on capital for one month is 20%. I mean, that’s the most simplistic way to do it. And that’s fair.

Robert Leonard  28:39

So that’s exactly how I’ve typically gone about it. But then I was thinking the other day as I was preparing to chat with you. And I’m like, if the trade successful, we get all that money back, say we get that $500 back. Now, our cost basis is essentially zero, right? And we made return without any money at risk. So now what is our return? It’s infinite, right?

Tom Sosnoff  28:57

Yeah, it’s basically basis reduction is what you’re talking about. The original concept behind options when retail customers got into option trading originally, it was really all about improving your basis. So for example, you buy a stock, and then you sell a call against it, that’s out of the money. And then essentially, what you’re doing is instead of buying the stock at $100, you’re buying the stock at $98.

If the call expires worthless, it’s all about improving basis. If you’re want to get short a stock, you sell an out of the money put against it, and you improve the amount. Instead of selling it for $100, you’re selling for $102. So effectively, what you’re doing is you’re improving basis. The whole business of options was about improving basis for one person. For one set of people, it was about speculative leverage and for the other set of people it was about improving basis. Those opportunities and risks still stand true today, except today the markets are much more strategic. So there’s even more things you can do, which didn’t exist in prior decades.

Robert Leonard  29:50

We’ve talked a lot about the benefits and the upsides of options. But what are some of the risks and downfalls that options provide?

Tom Sosnoff  29:58

A lot of people trade too big. So one of the things with options, we have a philosophy at the firm, which is trade small trade often. Trade small, keeps your risk in check, and often gives you law of large numbers. The mistake that virtually everyone makes that gets them in trouble is size. There is no issue in the whole world of finance, other than size.  But if you believe, like I believe that markets are random, ultimately, markets are random, that nobody knows what’s going to happen next. I’ve been around the block enough times to know, nobody knows what’s gonna happen next. And given that, the only thing that can get you in trouble and the only way that you can manage risk is based on the size of your positions.

Ultimately, you can do certain things that are very mechanical, like you can sell the right Delta, you can sell the right number of days, you can buy the right Delta, you can buy the right number of days, you can do all the things. When you get in your car, and you’re going somewhere, you can’t control what other people are going to do. But you can control your own risk. You can wear your seatbelt, you can not drink, you can not be on the phone, you can go the speed limit, those are the things you can control.

In trading, it’s exactly the same way, and options even more so. Take care of the things you can control, opening the trade at where you want to do it using the right strategy, being diversified amongst strategy and underlyings. Having the right number of mechanical days having the right price objective, choosing the right Delta, all that kind of stuff, you can’t control what the stock’s ultimately going to do. So just have the right size on. Stay small.

Robert Leonard  31:33

For anyone who has studied Warren Buffett, they likely know that he’s actually quite an options trader, or just an options investor, if you will. For those who haven’t studied him, they probably wouldn’t know that because it’s not really publicized. Why don’t you think Warren Buffett’s options strategy is as widely covered in the financial news,

Tom Sosnoff  31:52

Warren Buffett’s been a little on both sides of the fence on this. I mean, one of the famous Warren Buffett quotes are, you know, derivatives are basically weapons of mass destruction. That’s one of his famous mass financial destruction. The other side to it, you know, he’s probably made billions of dollars selling option premium. When you’re long a lot of stock, you can sell a lot of premium, or when you want to get long a lot of stock, it’s mathematically most strategically viable way to get long theoretical stocks. People that don’t understand options and derivatives don’t understand that they’re the exact same thing as buying or selling stocks, the theoretical equivalent is perfect, you can buy 100 shares of stock, or sell to, let’s just make it simple. You can buy 100 shares of stock, or you can buy two 50 Delta calls. Theoretically, it’s the exact same thing at the exact same time, there’s no difference. You can buy 500 shares of stock in the Spyders, for example, the S&P 500 ETF, which is the most actively traded product. you can buy 500 shares of Spyders and you can buy one S&P e-mini futures. Or you can do 10 at the money, Spyder options, and they’re all the exact same thing. And people think, Oh, my God, that’s so much different. They’re not they’re all the same thing. Theoretically speaking, they’re exactly the same at that moment, no difference.

Robert Leonard  33:16

What would lead somebody to one strategy over the other?

Tom Sosnoff  33:19

Either a lack of know how or capital efficiency.

Robert Leonard  33:24

And so is Buffett selling out of the money calls essentially, on stock that he owns a lot of basically, so if he owns, say, 100 shares, but say he owns more than a million shares, would he sell an out of the money call in if the stock goes up to that price he has to sell?

Tom Sosnoff  33:39

Generally speaking, I think given the size and the scale that he has of his underlyings, I don’t think he sells a lot of calls against his position. I think Warren Buffett, from what I’ve read over the years, he’s much more of a put seller, and an index put seller, so he’ll sell, let’s say a billion dollars worth of S&P puts after a huge download that kind of thing, and then hope they expire worthless, you know, a year from now.

I don’t think he’s a very sophisticated options trader. I don’t think he has to be when you have $50 or $100 billion, I don’t think you know, we’re gonna judge him on his skill level of if he understands gamma risk or, you know, whatever else it is, but I think he’s been ridiculously successful because of something that, that he doesn’t have to deal with, that you have to deal with is the emotion of potentially pain. Whereas a small investor has to worry about their portfolio size and their net liquidating value. And somebody like him  can take a billion-dollar shot and you’re going to be fine.

Robert Leonard  34:39

What do you think about those out like long dated, say, put strategy say we want we’re talking about selling puts earlier? We’re talking about selling them at 45 days? What if we sell them a year out? Two years out three years out?

Tom Sosnoff  34:51

It’s not an interesting strategy to me. There had been different points in history after huge down moves and volatility explosions, where I think it’s interesting maybe to consider it. But generally speaking, long-term options for me it’s like trading a stock, it’s not that interesting.

Robert Leonard  35:12

Is it just because it’s not active enough?

Tom Sosnoff  35:14

That’s right. And you’re limited what you can do with it, and you’re stuck in that position forever. You know, one of the things I love about what I do is, every month, I get a clean slate. Every year, I get to start over. Every month, I get a clean slate. It’s really cool. I like the fact that that I get to essentially start over all the time.

Robert Leonard  35:33

When I think about these long, dated put strategies, I have a hard time imagining that say a company, Visa, right? Say we sell it $50 under where the strike price is $50 under where the share is, today, I have a hard time believing that visa is not going to be higher than that price in two years. I just find even if we have a recession, I have a hard time that you know, markets typically go up into the right so I find it hard to think that just macro thinking not we’re not getting into the nitty-gritty of options.

Tom Sosnoff  36:00

You’re a millennial, you are right smack dead center, my son’s just a year or two older than you he thinks the exact same way. You guys can be twins. Earlier this year in March, you got your first whiff of a bear market, but it didn’t last very long. And you have never seen anything that is prolonged for longer than I mean, you saw this March when the pandemic news broke, you saw a 35 day bear market of 30%. Imagine that market went down. So let’s say you did visa $250 in the stocks trading $250.

Robert Leonard  36:35

214.

Tom Sosnoff  36:36

I think ish, yeah, $214. So let’s say you sold the 150 puts. Let’s say I went out to January of next year 300. And January 22 381 days away, and I went down and sold the 150 puts they’re $5.50. So they’re pretty, they’re pretty far out of the money, they have a delta of 12. That means statistically, there’s about an eight to 10% chance that it gets under 150. This is right in your wheelhouse. You collect five bucks for making that trade.

Now, remember that, even though there’s only a 12%, or 10% chance of getting down to that 150 level, if we went into a prolonged bear market over the next, let’s say a year or so, the idea that Visa couldn’t go to $50. I mean, it easily could and the amount of capital that trades going to tie up easily go under $100. And and for that stock to be cut in half, you remember, in the financial crisis of 2008, you were only 13. But in the financial crisis of 2008, stocks, like Visa went down to single digits. So we’re not talking about like $100, we’re talking about like under $10.

I don’t remember exactly how low Visa got during that whole move whatever it was. But we’re talking most of the stocks got under $20, or $25. and other financial stocks got under $10 and Visa is a financial stock. So I’m just guessing was under 10 bucks. So when you look at that, and the stock was probably $150 at the time, you’re not thinking it’s gonna lose 90% of his value, but it could happen. And again, I understand that I understand how positive drift works. And I understand, you know, kind of how markets work over time. But it’s not a guarantee.

Robert Leonard  38:12

So is that a strategy that’s better used? If we had already seen a sell off? Then you implemented then?

Tom Sosnoff  38:17

I think so. If you’ve already seen a sell off, then look at Visa for a second. I mean, yeah, it’s a strategy that where do you think Visa got to in March, just in March.

Robert Leonard  38:29

I bought a lot of Visa in March. So I think my cost basis I think was around like$ 140 ish.

Tom Sosnoff  38:35

You bought almost a low. $135 was the low in March, and we barely went down, we only went down to 30%. If this market had sold out 50%, that stock would have been about 80 or 90 bucks. And if you had sold the 150 puts, you would have been nervous as hell. But the fact you know the only way to protect yourself and somebody that played you wanted to go out and sell a put in visa two years from now, I would sell it into a down move when it’s scariest time. And I would also say super small. I would not do it at all-time highs, Visa’s to ticks off all-time highs.

Robert Leonard  39:06

And when you say small one, two contracts?

Tom Sosnoff  39:09

Well depends on the size of your account. For a millennial- one, two contracts, right? And if you’re Warren Buffett- 10,000 20,000 contracts, whatever it is.

Robert Leonard  39:17

When we think about selling calls on the upside, a lot of people argue that that’s not necessarily a great strategy, because of this drift that you mentioned, stocks typically go up and you’re limiting your upside. What do you think about that strategy?

Tom Sosnoff  39:28

I think it’s absolutely fine. And especially 12 years into a bull market. I think it’s better than fine. I mean, the hard part about selling calls is over the last two decades, it’s been less effective than selling puts. But I think over the next two decades, it’s actually going to be a more effective strategy. Because I don’t think you’re going to see the same upside velocity that you saw over the last 12 years. So I like the idea of selling calls for the next decade.

Robert Leonard  40:01

As we round off the show, what’s the best piece of advice that you can give to the listeners of the show, it could be about options trading, entrepreneurship, investing, or maybe even just life in general, what advice has really impacted you throughout your career?

Tom Sosnoff  40:15

It’s pretty simple. I think, for me, I shouldn’t speak for anybody else. I tell this to my own kids. I tell this to everybody that I taught, I talked to lots of students millennials, and you know, whether they’re employees or anybody friends doesn’t matter. It’s really weird.

But one day, you’re 25, like you are today. And you’re gonna close your eyes. And the next thing, you know, you’re 50. And you’re gonna wake up, and you’re gonna go, where the eff did my life go. you’re literally going to wake up and you’re 50, like, I still think I’m 25, and I’m 63. You do close your eyes one day, and you wake up, and it’s 25 years later. So my advice to everybody listening is every opportunity in your life that you have to take measurable or calculated risk, go for it.

Don’t ever hold back not even once, like, don’t sit back and think about it. And I’m not talking about, like, you know, doubling down on 11, when you’re in Vegas with everything you have. That’s not the life advice I’m talking about. But every chance you have to do something where it’s kind of a risky decision. But if it works out, the payout is going to be greater than the risk, you should take it. We call that pot odds. And every opportunity, you have to take risk, every decision that you get to make, like people say to us all the time Well, we built 2 billion-companies in the last 20 years. That’s pretty cool.

Every opportunity we’ve had to take risks over the last 40 years, we’ve done it. Every single one. And I would say that the reason we’ve been successful is because we are not afraid to make a decision and take risks. And that’s even at this age at 22, or 23, or 25, or 27 or 30. Take every bit of risk you can because otherwise you’ll regret it forever.

Robert Leonard  42:05

That’s really timely advice. And actually good confirmation for me. And I’ll tell you a quick story. Because I raced motocross growing up that was kind of my background. And then I stopped when I was 14, I didn’t race for 10 years. And then when I was 24, I got back on a bike again. I was mostly just doing it for fun. And before I was on track to go pro, I had some big contracts. When I was 14, a couple things happened. I didn’t end up going pro but so when I got back into it when I was 24, I decided I wanted to just do it for fun. It’s like my biggest passion in the world.

And then I started to think there’s this race in Tennessee. It’s the largest amateur motocross national in the world. And there’s a big qualifying a bunch of qualifying events that you have to do to get to it. And I said to myself, I said, if I don’t try to make it to qualify for that event, I’m going to regret it. I said, I’m gonna wake up, like you said, when I’m 50, and I’m gonna regret this. So I went out, I bought a dirt bike, I started training again, and this summer, I’m going for it. You know, it’s one of my biggest things. And it’s just so timely to what you just said,

Tom Sosnoff  43:00

Yeah, I’m telling you, and this goes with life and business, personal stuff, just everything. I’m not talking about taking stupid risk, either I’m just talking if it’s calculated, whatever it is. And even if you, you know, assuming I mean, hopefully you qualify, you win whatever it is. But even if you don’t, you’re not going to regret it. I mean, it’s going to be it’s going to make you think differently about every other decision you get to make. There’s a lot of schools of thought about things like the power of decision making, and the power of taking risks. And for people that make a lot of decisions and take a lot of risks and their chances of being successful are almost 1000 times greater than people that don’t. You have to respect that that is a very, when we hire people to work for us. We want people that can make decisions. That’s the most important thing to us. Can you make a decision? Answer a question fast, I don’t care if you’re wrong, just make the decision.

Robert Leonard  43:57

Tom, thank you so much for joining me today. It’s been a true honor. And it’s an interview that I’ve looked forward to for quite a while now. Where can everyone listening go to learn more about you and all the different things you’re working on.

Tom Sosnoff  44:09

If you want to watch me if you want, if you can take any more of me, every day from 7am-10am, we do a show on tastytrade.com it’s free. It’s called TastyTrade Live 7-10am, Central Time, Eastern time, it’s 8am to 11am. Then we’re back on again in the afternoon for what we call “Last call” from 2:30pm to 3:00pm central time. And then if you want to check out our our brokerage firm, it’s called Tasty Works. You can check that out at www.tastyworks.com. It’s the coolest piece of technology out there for trading. It’s an amazing platform.

We also own another app called Dough.com which is another brokerage firm. We have a magazine called Lockbox, which is a fun magazine to read and it’s free to go to get Lockbox and it’s a digital magazine and it talks about trading and life and everything else. This month’s issue is on the art and science of forecasting. I think that’s a good start. We have a great learning center on www.tastytrade.com. And listen, if you want the coolest technology around and you want to see all the stuff that we do, and you want to do some of the stuff that we talked about today, just check out our stuff.

Robert Leonard  45:18

I’ll put a link to all those different resources in the show notes below. So everybody listening can go check it out. I highly recommend that you do. Tom, thanks so much for your time.

Tom Sosnoff  45:26

Thanks so much. Thanks, everybody.

Robert Leonard  45:28

Alright guys, that’s all I had for this week’s episode of Millennial Investing. I’ll see you again next week.