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I'm not sure if this is the right forum for this but we have a lot of smart individuals on TL. My dad is a smart guy, but a bit naive at times especially if it has anything to do with technology. Recently he got into trading binary options online, the basic premise is basically at 3:25 or so, you can put down i.e. $100 that XYZ stock will either increase or decrease by 3:30. If you are wrong, you get $15 back, if you are right, you win ~$70.
I've done a bit of research into this and have come to the understanding that this is a game that can't be "beaten" in the long run (although this is mostly conjecture from random posters on forums as opposed to say, an article about it on WSJ). If it is, it requires a ton of studying and knowledge, and probably not worth it as an endeavor overall. As a professional poker player myself it's also obvious to me that any site offering this structure probably has an inherent edge over the player (in the same way the casino has an edge over players in blackjack). I think my dad is up money so far, but I have a hard time convincing him that it may be just shortterm variance and that his bets are likely losing propositions in the longrun.
If anyone has a simple, pragmatic way of convincing him to stop playing I'd greatly appreciate it. He used to be a lawyer and has followed stocks for years, and he tells me that there are logical patterns in the stock charts which to me just sounds very past-results oriented. I've told him on many occasions to just trust me and to stop, but now I understand this must be what he felt when I first told him I was playing poker online lol, so I think without some effective way of convincing him, my words don't have much weight.
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2nd Grade Probability:
The very idea of "binary" options suggests that the chances of one or the other at any given time is around 50/50 (expected).
First, you have to bet $100.
If you win you get let's say $75
If you lose you lose $85.
Therefore, in order to break even (not including commissions mind you which can be anywhere from 5-35$) you would have to be at least p1(75) = (1-p1)(85) which means he'd have to be at least 53% sure that the stock is going to go in the way that he indicates. But the fact that the time frame is low makes this virtually just like gambling, except that larger instiutions have a huge advantage. Suppose large bank ABC places a bid on XYZ, then proceeds to purchase XYZ at a higher price, thus driving the cost up. They can sell the XYZ at any time and proceed to collect the profit from the binary options. I doubt your dad has enough capital to pull something like that.
Tell your dad that he'd probably be better off in the long run by challenging people to heads or tails.
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Assume x = decimal chance of winning in this bet.
70x - (1-x)*85 = 0
85=155x
.54839~=x
Your dad needs to be right 55% of the time to break even. This is obviously the sites advantage (assuming they don't charge a transaction fee).
Your dad thinks that it is possible to predict the stock market, but in an interval of time of five minutes, stocks are very volatile (no?), and I doubt even many professional stock traders could do it well through skill alone.
I think you should look for sites disproving this type of trading as a scam, see what other people have had to say about it.
Then perhaps agree with your dad to stop playing poker if he stops gambling as well.
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My fear is that he'll think he's better than a ~55% favorite on his bets. The math breakdowns and such are good though, thanks guys.
Hidden: The irony is that I've turned the hobby into my career and he's now 100% happy and supportive with what I do :x
edit: ok I've pretty much combined the reasoning in both of your posts and wrote down the math all on a piece of paper and will show him in a bit, thanks again 
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On July 16 2010 07:07 Caller wrote:
2nd Grade Probability:
The very idea of "binary" options suggests that the chances of one or the other at any given time is around 50/50 (expected).
Binary doesn't suggest anything about probability, only the number of outcomes.
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On July 16 2010 07:23 Issorlol wrote:Show nested quote +On July 16 2010 07:07 Caller wrote:
2nd Grade Probability:
The very idea of "binary" options suggests that the chances of one or the other at any given time is around 50/50 (expected).
Binary doesn't suggest anything about probability, only the number of outcomes.
Why not? If you have only two outcomes and the outcomes are more or less independent from each other, then his conclusion is correct, or not?
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No. Independence doesn't imply that each outcome is a specific probability, only that one outcome happening doesn't affect the chance of the other outcome happening.
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So that they're mutually exclusive :D
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On July 16 2010 06:57 PanoRaMa wrote:
He used to be a lawyer and has followed stocks for years, and he tells me that there are logical patterns in the stock charts which to me just sounds very past-results oriented.
This is True...ish from my limited knowledge on the subject. It's called I believe technical analysis. A former Investment banker gave a lecture on it and it seemed as if it has...reasonablish reliability? This is about as much as I know. It sounded like a mix of science and art to me.
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Well I just talked to him for about an hour and failed lol. He is aware of the probability disadvantage but feels he has an edge. He started describing all sorts of stock-related stuff that I didn't really understand (I think one of the things was that you didn't have to bet on the result within the next 5 minutes but over time or something, idk) and we talked back and forth a lot and made a million analogies etc. He'd say, if example an oil tanker blew up, clearly the stock would plummet. I don't know much about stocks but I tried to express that if it were that easy millions would be on the binary options sites and the sites would be bankrupt. Ultimately it was my ignorance of the field that couldn't convince him that his edge wasn't as big as he thought.
I even described that the model translates to the site effectively raking you 5% uncapped which in the gambling world is a pretty high fee.
Apparently he's up 2500 betting $100 and $50 - the best I could do was warn him about letting variance/luck affect his perceived skill.
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Some investigation from google produced this:
http://www.informedtrades.com/400196-binary-options.html
The seller obtains an advantage 2 ways. The first is binary options cannot be exercised early. The second is that they have a fixed payout.
Let’s say an option writer writes a regular naked call option (sells a call option on a stock that he does not own, and also he does not own another option to protect him from large losses). That option has unlimited risk, because technically the stock price has no upper limit.
In option pricing, volatility is everything. There is historic volatility (how much the stock has gone up and down in price in the past), and implied volatility (a calculated guess on how much the stock may go up and down in the future).
By making the payout on these a fixed amount and limiting exercising to the expiration day, they are taking out much of the uncertainty. This gives the binary option seller a statistical advantage. A simplified way of saying it is that statistically a binary option seller has a better than 50-50 chance of coming out ahead over time selling them, and statistically a binary option buyer has a less than 50-50 chance coming out ahead over time buying them.
The major point here is that binary options are falsely "safe". In purchasing the options, your father is essentially saying to the seller "I don't want to risk more than X, so if you will take all losses over X, I will give you all winnings over Y". Statistically, this averages out in favor of the seller, not the buyer (namely, not your father).
If that doesn't work, last resort:
You say he's a smart man, so he should readily grant that binary options are a zero-sum game, even before the "rake". The only way he can make money is by someone else losing money - because, in the act of trading a binary option, no value is created anywhere. It is speculation, and speculation is by default zero-sum.
Zero-sum games/systems are never stable unless the win/loss ratio is extremely close to even. Nobody will continue to play a zero-sum game when they're losing 60% of the time, because that is identical to just giving away 10% of your money.
So, if he honestly believes that he is making money, he must logically believe that someone else, somewhere, is losing a correlated amount of money (more, because of the way the dealers set the prices). This person will not continue to do this indefinitely.
However, binary options are not new. They have been in place for a long, long time. This is not a possible outcome of a system in which payouts are skewed heavily in one direction.
Therefore, as a matter of pure logic, he's only up because he got lucky*, and, given time, he will lose just as much and eventually average out to breakeven.
*Possibly. The part that I'm not sure about relates to the fact that stocks, as a whole, are not zero-sum. If you invest in a fund that covers the entire stock market, you will generally make money. Speculation on stocks is zero-sum around this point, not around zero - individual speculators basically never consistently make more than the stock market as a whole made. Thus, depending on how exactly binary options interact with the market, your father might see returns located roughly around the returns generated by the stock market he's betting on - but, still, he's basically throwing away money compared to investing in an index fund.
I wish you luck, but most people are of the opinion they're special and can do something that tens of millions of other people have tried unsuccessfully. In most cases, the only thing that will teach them otherwise is losing money.
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Risk does not equal return obviously. I think he also needs to know that you can not consistently predict stock prices in the long term. Much less the short term. Finance theory calls the price changes as a "random walk". If your father knows how a stock behaves, then why doesnt he just throw down on e*trade?
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Sounds like a self-justified gambling addiction. No amount of reason can get through to him, just keep a close watch on his net gain/loss and jump on any chance that he starts losing money.
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On July 16 2010 10:46 itzme_petey wrote:
If your father knows how a stock behaves, then why doesnt he just throw down on e*trade?
He has long-term and mid-term investments, he considers this to be a short-term investment.
I'm not sure if it's his form of degenerate gambling, he's pretty risk averse in general.
But thanks for the input everyone, especially kzn.
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On July 16 2010 11:29 PanoRaMa wrote:Show nested quote +On July 16 2010 10:46 itzme_petey wrote:
If your father knows how a stock behaves, then why doesnt he just throw down on e*trade? He has long-term and mid-term investments, he considers this to be a short-term investment. I'm not sure if it's his form of degenerate gambling, he's pretty risk averse in general. But thanks for the input everyone, especially kzn.
TBH I think you just hit it on the nose there. I think your father may just be addicted to gambling. No matter how you spin binary trades, its just gambling. Maybe you should look into getting him to open up about how he feels about gambling and just go from there? It seems he is justifying this type of gambling by putting an "investment" spin on it.
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On July 16 2010 11:29 PanoRaMa wrote:Show nested quote +On July 16 2010 10:46 itzme_petey wrote:
If your father knows how a stock behaves, then why doesnt he just throw down on e*trade? He has long-term and mid-term investments, he considers this to be a short-term investment. I'm not sure if it's his form of degenerate gambling, he's pretty risk averse in general. But thanks for the input everyone, especially kzn.
Latching on to one thing you mentioned:
You could try explaining that the idea of a "short term investment" is pretty ridiculous. Investment means putting your money into something with the expectation that, with some work and value added etc, you generate a return.
Long-term investments make money because you put, say, $1000 into a new tractor. The tractor makes you more efficient at farming, so you have more produce to sell every year after you have the tractor. The return on the investment is the amount of money made by selling that extra produce.
But a crucial point here is that it takes time. You dont just put $1000 into buying a tractor and then sell your tractor for 5% more money - that money has to come from somewhere, it has to come from work.
Short-term investments make tiny amounts of money. Any time you make a "short-term investment" and make more than like 0.5%, you just got lucky.
[edit] and hell, even 0.5% is a bit much - I'd be surprised if you could consistently make 0.5% returns off of 1-month long investments. The amount of money that counts as a real return from a 5 minute investment is probably less than a thousandth of a percent.
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Tell him to stop with this rigged crap and take a look at those stocks that are calculated based on the value of indexes... I forget the appropriate term... But with foresight, you can actually win big on those. Its basically like trading a commodity, except the commodity is the value of the index.
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thedeadhaji
39489 Posts
two thumbs up to kzn.
predicting the market in 5 minutes is utterly absurd... MAYBE a month and you can do this by looking at world economic trends...
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17066 Posts
On July 16 2010 07:07 Caller wrote:
2nd Grade Probability:
The very idea of "binary" options suggests that the chances of one or the other at any given time is around 50/50 (expected).
Just to reiterate what a previous poster pointed out, this is flawed.
Whether or not the sun will rise tomorrow is a binary option. The chance of it rising tomorrow is virtually 100%, and the chance of it not rising tomorrow is virtually 0.
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On July 16 2010 22:47 Empyrean wrote:Show nested quote +On July 16 2010 07:07 Caller wrote:
2nd Grade Probability:
The very idea of "binary" options suggests that the chances of one or the other at any given time is around 50/50 (expected).
Just to reiterate what a previous poster pointed out, this is flawed. Whether or not the sun will rise tomorrow is a binary option. The chance of it rising tomorrow is virtually 100%, and the chance of it not rising tomorrow is virtually 0.
Lol but the chance of some stock going up in the next 5 min is 50%. What point are you trying to make here?
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EPT
