by x3lr4
I see a lot of people just YOLO’ing their life savings on the next meme stock here. Yes, it’s more fun than buying a lottery ticket and your chances of success are higher. Wait, are they?
As a physicist and mathematician, I feel the need to at least tell my fellow autists how to bet properly.
There’s something called the Kelly criterion, which tells you whether a bet is favorable or not. I’m not boring you with the details, so just read the article if you’re smart. But at its core it’s a really simple formula:
f* = p - q/b
, where f* is the Kelly criterion, p is the probability of success, q is the probability of going tits up and b is the profit-risk-ratio.
Trading software like TWS and many others give you the probability of success, based on a lognormal distribution, when you create an order. So p and q are known. f* needs to be positive, the bigger the better. b is what we want to know.
Here’s an example:
p - q/b > 0
p > q/b
b > q/p
b > (1-p)/p , because q = 1-p
b > 1/p - 1
I wrote out every step, so even the biggest idiot can understand it. So if your probability of success is 70%, your profit-risk-ratio needs to be 1/70% - 1 = 42.9%. That means if you risk $100, you need to potentially earn at least $43.
But those numbers are only interesting for the theta gang and them losers in r/investing.
My strong handed r/wallstreetbets friends, with balls made out of steel, need an example that better suits their need for the ultimate thrill.
So let’s say you buy a call that is 20% OTM at 280% IV. For example a Feb’28 40c on $SPCE. The underlying is currently at $33 and the call costs $3.50.
This will give you a 27% chance of success, so the profit-risk-ratio needs to be 1/27% - 1 = 270%. If you exit these trades at less profit than an average 270% on your investment, math clearly states that you’ll definitely go tits up.
If you bought this Feb’28 40c on $SPCE for $350, you need to sell it for at least $1,297 (on average over all your trades). It’s even a bit more, because of commissions.
Now listen, this is the optimal way of betting, but there’s still a risk of going bankrupt. If you do an evolution on the Kelly bet, more than 75% of them diverge (go to infinity), but almost 25% still converge (go tits up). So people like Warren Buffet only do 20%-50% of the Kelly criterium.
I hope you retards actually learned something.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.