Horizontal links

Tuesday, 28 April 2015

Risk Management vs Money Management

They are not the same.

Let's use the Singapore Pools' 4D example as most Singaporeans can relate to it:

Money Management

$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?)

Risk Management

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 specific options broker or platform to you. Why do tour guides bring you to a specific retail 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 Risk 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



  1. Hi SMOL,

    Love the way you incorporate Singapore Pools into the picture to explain it so clearly.

    I do have to mention that while it is true that writing options will result in unlimited losses (20-30% of the time) and limited profits (70-80% of the time), It is ultimately how you choose your strike price and where the breakeven points are that determine if you will be profitable or sitting on losses.

    On another point, you can always choose to close the position if it hits your stop loss or whenever it is that makes you uncomfortable holding the position overnight.


    1. investing wolf,

      Hey! We have the same Blogger template and welcome to this watering hole!

      I'm glad someone like you with actual hands on experience with selling options is sharing with us what it takes:

      1) Determine strike price

      2) Choose breakeven points

      3) Maintain stop-loss levels

      4) And much more like how much to risk per trade and more...

      It doesn't look very "passive" is it? And that's the point I was making.

      If we go in with eyes open, we're the man!

      By the way, stop-loss is useless if the market gaps up/down 2 to 3 standard deviations like the recent EUR/CHF WTF moment ;)

    2. Hi SMOL,

      Yea, same template :D Glad to join the party of like minded "Financially Free" people

      Been selling since last year and I have to say, as long as you do not risk too much per asset class, you can compound quite nicely. I only sell options which i deem to have a very low chance of ever being in the money and so far it's been doing well.

      It is nearly the same if not easier than determining the intrinsic value that value investors do before they purchase a stock (still have to read up on the annual report, economic moat, etc.).

      Technically I only concentrate on (1) and the ratio of Premium: Margin. I do not even consider breakeven or stop loss unless it is a stock option (my major is in options on futures). My stop losses on future options are always set based on my premiums hence i do not need to calculate.

      I agree that most stop losses are useless but if you observe carefully, all asset class will gap down/up depending on the market sentiments. If you bought CLDN eariler and the company announced bad news over the weekend, it is sure to gap down (now, aren't you glad you had the stop loss in place to sell out at the next available price instead of manually fumbling to login/call your broker to exit the position?).

      It is also to mention that options have a lower movement compared to their underlying assets. If a stock has a delta (option term) of 0.5, it means that when the market moves $1, the option only moves $0.5 (now doesn't it look more appealing to lose $0.5 than $1 :P)
      *hint: use options only for stocks or futures, not currency

      Normally when i place a position, i do not need to look at it unless the underlying moves significantly against me (only look at it when the news reports a huge market movement or when i'm looking for more opportunities).

      Sorry for long post :P

    3. investing wolf,

      I think AIG and Long Term Capital knew how to calculate risks too.

      Bookies have been known to run road...

      It's never the risks that we know and can calculate that kill us. It's always the unknown unknowns ;)

    4. SMOL

      Unlike CDFs, Options are regulated by the option clearing corp in the US. so no worries on the company running unless your broker is unreliable (in which case you need an accredited US broker).

      That's y do not go into things you do not understand. I only sell options on assets i understand. FYI, selling covered calls on stock options for extra income and selling naked puts for value investors can be easily understood and applied for all (don't need to have all the complicated greeks or on other asset class you do no understand, etc).

      There are many real assets an option can be used on. just do not use an option on a derivatives (it is like leveraging on a leveraged asset which will kill you instantly) and you wont end up like those companies.

    5. investing wolf,

      Hear, hear - "That's y do not go into things you do not understand".

      I'm with you on this point ;)

      Many Singaporeans have experience with options (some without realising it), especially when buying HDB flats - Option to Purchase (OTP).


  2. ToTo is low risk gambling and common sharing money management.

    Anyone heard of someone losing their pants betting ToTo?

    1. CW,

      And that's why I've been buying Toto for years.

      It's my hedge or counter-balance to the insurance premiums that I've been flushing down the toilet if I don't make a claim ;)

      Buy term and speculate the balance on Toto?

      Oh! I'm such a bad influence :(

    2. With the ability to compare insurance plans set upon by the MAS, you can now choose which plans are good for you... (in terms of paid premiums vs coverage. Hence you do not need to overpay for a undercoverage plan and let your insurance agent earn the commissions.

      I never bet on Toto or 4D as the chances of winning are not in my favor (it never is). I believe we should concentrate on potential FOR profit instead of potential profit.

    3. investing wolf,

      I am conscious of my mortality and humbled by my propensity to make mistakes.

      The tale about Nassim Taleb visiting Victor Niederhoffer before Niederhoffer blew up selling naked options has forever been edged in my memory.

      I rather buy Toto or Big Sweeps for I can be wrong a million times and still be standing tall. The small losses won't kill me ;)

      I guess the reasoning is the same for those who buy hospital and medical plans - pay a bit annually (known loss) to protect against a huge unknown and unlimited medical bill shock ;)

    4. SMOL

      Haha... that's where i know i would require it in the event i have an accident or get admitted (touch wood).

      Being in the option selling line, is similiar to being the insurance company. However, it comes with the benefit of closing the position when i see a loss coming.

      Imagine if your insurance knows that you are buying a sports car and have gotten into an accident. If they have a chance to close your plan for a small loss, i bet you they would gladly do it in case you get into another accident and they make a huge loss for insuring you.

      But being the insurance company, they can only increase your premium next time and if they feel you will just keep getting into accident because you are young and reckless (many speeding tickets) , they can choose not to offer you any car insurance.

      :) just want to point that out :)

    5. investing wolf,

      That's the difference between money management and risk management.

      The theory is we can cut-loss quickly (money management); the reality with fat-tail events like Black Monday, Flash Crash, Swiss National Bank shock (risk management), try getting out with a small loss when liquidity dries up ;)

    6. SMOL

      Those mentioned affect all financial instrument. So if it happens again, none of your positions will be safer than mine (as a matter of speaking). And we all bear the brunt of the crash.

    7. investing wolf,


      That's the name of the game - how much we make when we are right; and how much we lose when we are wrong ;)

    8. SMOL

      Yea totally agree with that! In the end as long as we do not lose, we can always earn it back.

  3. we do have life policy to ensure that we pass on our family will at least be able to cope for a few years due to loss of income from breadwinner
    why life policy is a no no?

    1. Jimmy L,

      I think you misunderstood.

      Most other types of insurance (leg Term life) has an expiry date - and like options, if not exercised or claimed before the policy expires - the premiums we have paid would be akin to flushed to the toilet.

      We have subsidised those who made a claim. It''s a collective scheme where the many pays for the few.

      Wholelife insurance is "different" as it covers for "life". And since everyone dies, all who signs up is a "winner" and will collect eventually ;)

      Those who collect "earlier" wins in a morbid kind of way due to the lesser premiums paid if we really want to split hairs on "winners" and "losers" ;)

    2. Haha don't want to be a winner in this case

    3. Exactly.

      Insurance is a very interesting product.

      We win when we lose; and we lose when we win.

  4. I remembered how when I won $20 in toto, ACCICB laughed at me. I was happy though since I hardly buy toto in the first place and even happier when a taxi driver told me he has been buying regularly for years and yet to win any money!

    1. Joyce,

      We need a bit of these "unexpected" surprises in life to spice things up a bit ;)

      It''s no fun if you had spent $50 on Toto quickpick and won $20 :(

      But if it''s $2 quickpick.. Hey! That's your 10 bagger!

      I am still hoping for my "big one". If I didn't strike during my lifetime, well at least I've done my share for the community chest :)

  5. SMoL,

    Singapore pools still include Soccer betting.. lower odds of winning? But still u will loose!

    I lost all my savings/ hard earned tuition money during NS. No more SG pools anymore since then. I cannot remember when was last time I buy Toto or 4D!

    I prefer company lucky draw. Neutral or Win!

    For insurances, I had redeemed so many times accidents type, so that claims are way above premium I paid. Those life insurances are all ILP mis leaded by agents when I was a greenhorn!

    1. Rolf,

      Mental note to self: Don't accept free rides in Rolf's car! LOL!

      Just thinking out loud which is riskier?

      Buying $2 Toto quickpick for every draw or putting our life savings in the stock market?

      Which option has the better risk/reward?


    2. Hahaha.. not only car accidents, many injury accident claims.

      It's not about risk only... I go fortune teller, says my money all must be hard earned no "Lady Luck" in my life... and indeed very true... so I give up on gambling, 4D or toto.

    3. Rolf,

      Don't let me fade you out.

      I guess you have to figure out whether "investing" is 正财 or 偏财 in your circumstances ;)



Related Posts Plugin for WordPress, Blogger...