In the interview below, I talk to our good friend and veteran options trader Jared Dillian.
Paid-up Disruption Investor members know that one of our best recent trades was to buy “put options” on the S&P 500. We put on this trade as protection against a market decline. When markets struggled in March and April, we took profits after the trade gained 200%+.
A lot of you have written in with questions not just about the trade, but about options in general.
So, I thought it’d be a great opportunity to bring in Jared, who’s been trading options for 26 years... and just released an Options Masterclass.
In our conversation that follows, Jared shares his general guidance for new options traders (and the trap that many people fall into)… his approach to using options in today’s market… and much more.
We also talk a bit about his Options Masterclass, which you can get for 50% off here.
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Chris Reilly: Jared, from my perspective, options are the most divisive trading tool in finance. One on side, you have folks who go for 1,000% profits in a day with options. On the other side, many folks assume options are way too complicated and risky. What do you say to both camps?
Jared Dillian: It depends on what your objective is. Sure, there are some people who want to use the leverage and make 1,000% on a trade, but that’s not how I use options. I use them to manage risk. And you can create payoff structures with options that you can’t with just an individual stock.
There are a whole bunch of things you can do with options. For example, even in my trading I would say I use options on probably 60% of my trades by doing simple things like covered calls or buying puts... to call spreads or ratio call spreads… to straddles and strangles.
There’s really an infinite number of ways that you can create a payoff diagram that’s specific to you.
Chris: You said that options trading volume has exploded from about 2 million contracts a day when you were on the trading floor to around 12 million contracts a day today. How has this changed the options market landscape... are there new opportunities or pitfalls that exist today?
Jared: I’ll put it this way: Those 10 million extra contracts probably shouldn’t be traded. When I first started on the Pacific Coast Options Exchange back in 1999, options were pretty much strictly an institutional market. You could trade options as a retail investor, but it wasn’t that common.
And I would say that retail has totally taken over the market, although it kind of lives in very specific places, like tech stocks and the big ETFs and stuff like that.
So, depending on where you go in the options market, there might not be much retail activity. But what the retail traders can do is create distortions. You saw this with the degenerate call buying on GameStop (GME) and AMC (AMC), and it made those calls very expensive.
This creates opportunities... You can sell them, and if you can withstand the volatility, then you know you’re going to do great. But the stuff I generally trade doesn’t have a lot of retail participation, so it’s pretty accurately priced.
Chris: You’ve said, “I wouldn’t go into the options market without a shotgun and a flashlight.” Can you elaborate on that?
Jared: You really need to be prepared if you’re going to trade options. Options are highly mathematical. I have a degree in math, and it really helps. If you don’t have a degree in math, then you really need to spend some time learning at least about the underlying mathematical concepts.
You need to have some concept of probability. You need to know the basics of how calculus works. I would say if you’ve never taken a college calculus class, you probably shouldn’t be trading options.
What I try to do with my new Options Masterclass is take those mathematical concepts and express them in a way that even someone without that background can understand, and I think we do a pretty good job.
Chris: You recently shared a story about Alex, the former Chicago Bears player who was running the LMM (lead market maker) post at your market-making firm on the Pacific Options Exchange.
You wrote about how he almost blew up the firm when Yahoo stock moved $100 in a day... Alex “drops to his knees in the middle of the crowd on the trading floor and begins to pray.” Then the stock finally comes down...
What lessons from these trading floor experiences should retail traders understand about options risk? And what’s the biggest mindset difference between the pros and the amateurs?
Jared: The thing about trading options is that you have to have a really big imagination as to what can go wrong. Especially if you’re going to be selling options.
So in the story I told, this guy at our firm was selling a bunch of straddles and strangles on Yahoo before earnings, and this was a guy who had never really traded internet stocks. He was trading the slow, boring, consumer stocks like Colgate-Palmolive (CL) and Procter & Gamble (PG).
And if that’s your background, then it’s kind of hard to really imagine a stock going up 250% in a day after earnings. But if you can imagine it, it will happen.
So in the Options Masterclass, I talk about the risk of selling options. Because when you sell options, you’re exposed to unlimited losses. I think everybody understands that, but I think the trap that most retail investors fall into these days is actually buying too many options.
The reality is most options don’t go “in the money.” They expire worthless. And if you spend all your capital going around buying upside calls, buying downside puts, and waiting for these big moves... what happens is you just bleed to death over time.
Maybe that isn’t as catastrophic as what happened to Alex, but you’ll still lose all your capital. So it’s a balance.
Chris: Switching gears, let’s talk about what’s happening in the markets. Things seem to be settling down a little bit compared to last month.
There was a period last month where the S&P 500 went six straight days with a trading range over 5%. And markets can change on a dime with the latest tariff headlines...
I know volatility is good for trading. But is this environment good for trading options, specifically? Would new traders be better suited waiting until things get a bit calmer?
Jared: Well, I wouldn’t say it’s necessarily good or bad for options trading. Volatility is good for trading, but in terms of trading options, that definitely makes it more dangerous.
I mean, we had a day a couple weeks ago when Trump walked back the tariffs where the market was up like 8.5% on the day. And if you were positively exposed to that, then that was great. If you were negatively exposed to that, then that was catastrophic.
Volatility presents opportunities and it also presents risks. The one thing about volatility is that you have to keep your position sizes smaller, which is something that a lot of people don’t understand.
You know, you can trade in relatively big sizes when markets are calm. But when they’re not calm, you have to trade smaller.
Chris: Makes sense. So if someone has limited capital and they’re trying to decide between buying stocks directly or using options, do you have a framework or a general rule of thumb for how they should go about that?
Jared: I think people fall into this trap where they tend to want to use options too much. And they use options when really just buying the stock is good enough.
For example, I’m taking a position in an ETF right now. It’s a country ETF and I have a long-term view on it. So, I can buy long-dated call options, or I can just buy the stock. And if you buy the stock, you get the dividends... If you buy the calls, you don’t get the dividends—which is priced into the value of the options—but you’re not getting those cash flows. So it makes sense to just buy the stock.
I think people tend to overdo it with options and they tend to outsmart themselves. Options are best when you use them to mitigate risk in some way.
Chris: We bought put options on the S&P 500 in our flagship Disruption Investor advisory back in August, when insurance was cheap. And we recently took some profits, letting the rest of the position ride right now. What is the most common way you use options?
Jared: Probably when I’m actually speculating on a move lower. I don’t like to be short things, cause if you’re short something, you’re exposed to unlimited losses.
I don’t really have a lot of success shorting things, but you can buy puts. And I’ve been pretty successful at buying puts in the S&P 500, picking tops: Basically, profiting from a move lower and an increase in volatility. So that’s probably the most common situation in which I use them.
I’m not a big fan of hedging with options all the time because puts can be very expensive. As a general rule, if you buy puts all the time in a stock, it’s going to cost you about 10% to 12% a year just paying premiums.
That doesn’t really make sense unless you have a stock that’s going up 50% a year. So most of the time, I’m just buying puts and waiting for the market to crash.
Chris: You recently launched your Options Masterclass, and it’s gotten great reviews so far. You’ve said when trading stocks, you only have to think in two dimensions. Stock up. Stock down. Easy enough. But with options, you have to think in five dimensions, like the Bulk Beings in the movie Interstellar.
You also mentioned that, during your time on the exchange floor, you worked with both math PhDs and former construction workers who figured it out.
So, how does your Masterclass bridge this complexity gap? What’s your approach to making options understandable for serious investors who aren’t options specialists?
Jared: Well, there are plenty of books on options, and they range from the very simple to the very complex. You have “Options for Dummies” and books like that, where they have the hockey stick diagrams and you learn the basics, but not much else.
And on the high end, you have academic textbooks that take you through how to derive the Black-Scholes formula and all the math behind it.
There’s a book written by a guy named Sheldon Natenberg—called “Options Volatility & Pricing”—that strikes a pretty good middle ground, but it’s not super useful for retail investors because it’s really designed for options market makers. It was designed for the person on the floor back in the '80s and '90s who was making markets on options.
So you know, I really felt that there weren’t any kinds of texts that spoke to directional retail options traders and also gave them some of the theoretical background behind it. And that’s really what the Options Masterclass does.
Chris: You said that options are like riding a bike. Once you figure it out, it’ll stick with you forever. But you also said it took you about a year of being immersed in options, trading daily, to really get the hang of it.
So for the RiskHedge reader who wants to start incorporating options into their investment approach responsibly, it does seem to me like this Masterclass is a great place to start.
Is there anything else you want to mention about the Masterclass, maybe a little more about what someone can expect?
Jared: Well, I don’t want anyone to think that it’s only for beginners. I would say it’s a beginner to intermediate course with some advanced topics.
I’m sure there are some people reading this saying, “Well, I know about options... I’ve traded options for years. I really know what I’m doing.” I guarantee that if you took this course, you’d learn a lot of new things that you hadn’t thought of before.
So it’s not specifically for beginners. Although if you are a beginner, it’s a great place to start learning the basics. But everyone will benefit from this.
Chris: Great. Thank you, Jared. And reader, if you’re interested in learning more about Jared’s new Options Masterclass and want to start today, please go here.
