Asset 7
Asset 7
How to get started with Miiflo Reference Articles to Enhance Your (Flo)w How Robinhood rigged the game in your favor… and didn’t even know it

Robinhood, the American Financial Services company that helped usher in a generational shift in access and engagement with active trading and investing, sought to disrupt the investment industry by removing the fee structures (namely commissions) paid by individual investors to trade stocks. This innovation, along with innovations like fractional trading (buying parts of a stock rather than an entire share) have been so popular that much of the rest of the industry players have followed suit.

What they (Robinhood) didn’t know (or they haven’t said out loud) is how they also paved the way for individual investors to now place the same types of trades that successful institutions trade…something called “multi-leg option strategies.”

What is a “multi-leg option strategy?”

When most investors start out, they view investing as a “long only” game of buying stocks. This means you look for stocks to buy and hopefully someday sell at a profit. While simple to understand, this approach has a very low probability of success as humans are notoriously horrible stock pickers!

Buying stocks and making money is easy, the profit and loss chart looks like this….

Let us explain.

Suppose you want to invest in Shopify ($SHOP). Perhaps you believe in e-commerce and it’s a name that you see trending on Twitter or on investing boards. Let’s say you buy one share of Shopify. As of the day of this article it’s trading at about $35 a share. From where it is trading right now, the possibility of moving higher is 50%. Let’s imagine that you wanted to make $25 on that $35/share that you invested. That would mean that Shopify would need to trade an additional $25-$50 a share…. A 70% increase in the share price.

While that certainly could happen, you don’t know when or at what pace this could take place. You have no probability of success, and your capital is tied up for the indefinite amount of time that you want to get to $50 a share and even that price is arbitrary.

Now, let’s look at a chart of the stock…

After trading lower for much of the year….Shopify is now in a trading range.

To have a higher probability of consistent and predictable success, institutions and professional funds have used stock options to build “pockets” of potential profit around a stock. How does this work? Well, it’s something similar to the way that insurance companies make money even though they have to pay claims for property damage.

Insurance companies have actuaries that run the math to determine the probability of your home burning down in a fire. They then set the “premium” of the policy above that probability. If there is no fire….they keep the premium.

To capture this “premium” institutions and professional investment funds will use multiple option contracts simultaneously.  This is called a “muli-leg option strategy”

What Robinhood did for you

When Robin Hood set out to revolutionize and democratize finance they opened the door to possibilities that we don’t think even Robin Hood realized was in your favor.  By leading the way in removing commissions for self-directed investors, Robinhood lowered the barrier to entry to multi-leg option strategies…. Advancing ways to express an opinion on stock, but one with a defined probability.

So, now you can enter the same investment as an institution or professional fund!

What this looks like in Shopify

You can buy the stock. It’s $35/share. If you buy 1 share and it moves $1 you increase your investment by $1

Challenges in buying the stock:

  • How long will you hold it?
  • What’s the price target?
  • How much will it cost in capital?

What if you entered a MLOS instead?

For $25 of capital you could “sell” a multi-leg strategy in SHOP

What do you need? A brokerage account with “level 3 options” permission & $100 in your account to create a MLOS called an “Iron Condor.”  Here’s what the profit and loss graph looks like.  Quite different from the stock profit and loss, eh?

Here’s an order form showing 4 contracts as part of 1 order.  The price is a “credit” for $0.25.  As each option controls 100 shares, we can multiply by 100 to get $25.

We can see the total order here.  By selling 1 Iron Condor, we have a max profit of $25 AND a max loss of $25!

If Shopify is trading between 31.25 and 44.75 in 40 days, we get to keep the full $25.  That’s 100% return on capital!

In the past, this type of trade was cost prohibitive. Now, in a commission free environment…you can place this trade for no cost! That means if you are wrong (Shopify trades below 31.25 or above 44.75), you can simply the trade for a very small loss (if any) AND without having to also eat the commissions on top of your loss!

How Robinhood rigged the game in your favor… and didn’t even know it - Miiflo