They are not the same.
Let’s use the Singapore Pools’ 4D example as most Singaporeans can relate to it:
$1 bet can win $3,000 if bet with Small option.
Maximum loss is $1
Maximum win is $3,000
Risk/reward ratio is 3,000 to 1 (Good or what? A 3,000 bagger!!! Peter Lynch who?)
The odds of your 4D winning the first prize is 10,000 to 1 (Source: Singapore Pools website)
Seeing the whole picture
If I’m a snake oil salesperson trying to promote an investment/trading vehicle, of course I would only stress the Money Management part, and conveniently avoid mentioning the Risk Management part.
Anyone one here were sold on the benefits of buying Options?
At most can only lose the premium right? (Same as 4D example)
But our winnings are unlimited!!! (A bit like Toto snowball upsized!)
Isn’t the risk/reward enticing?
But what if I tell you now that 75% of options expire worthless? (Source: CME reports)
Can it be the same persons encouraging you to buy options are the same ones who are taking the opposite side of the trade against you? (Tip: Alarm bells should ring if the guru “strongly recommends” a options broker or platform to you. Why do tour guides bring you to a specific store?)
Live by the sword; die by the sword
Before you go rushing to write options, please remember that by selling options, you now have limited winnings (at most pocket the premium), but now have to bear the risk of unlimited losses.
How to visualise unlimited losses?
AIG for years were making good profits by selling Credit Default Swaps (CDS) to investors who wish to hedge against their bonds defaulting.
All it took was one Lehman event to bring down the whole AIG down (Is AIG bigger than our local banks?). Yes, the US government did bail-out AIG, but if you are a shareholder, your holdings were so diluted that at best you can only recover 10 cents on the dollar…
Yup, if you think your Rik Management is better than AIG’s, have fun writing options! And if you think selling options is “passive” income by collecting the option premiums every month, the best of luck to you!
Will anyone bail you out if you were wrong? Hey, don’t look at me.
Insurance for dummies
OK, not everyone is familiar with options. How about insurance then?
Think of travel, accident, critical illnesses, disability, term insurances and what have you. Must exclude Wholelife as we all will die one day (now you know why the premiums for Wholelife are so expensive).
Anyone have a habit of pooh pooh others who buy 4Ds, Toto, Big Sweep. Silly bunnies, don’t they know gambling is flushing money down the toilet?
Ah! But you do own some of the policies above right? And?
You were probably focusing on the Money Management part (or were sold to).
Bet you didn’t consider the Risk Management part.
Not feeling so smug now, are you?
Those who support Singapore Pools and those who overbought insurance products have a lot in common than you think!
P.S. Risk Management vs Loss Management
Singapore Man of Leisure (welcome to my blog; just google it!)