Investor 015
Episode 15
"Well, since we had a good meal, let me explain. Futures and options are both derivatives. Do you know the difference?"
"Roughly."
Sang-yeop Senior took a sip of his cola and began to explain.
"A future is a contract where two parties agree to trade a certain product at a specific price on a specific date in the future."
The reason for setting the price and date now, even though the transaction happens in the future, is because the price of the product is not stable.
If the price drops by the future date, the seller suffers a loss, and the buyer gains. Conversely, if the price rises, the seller profits, and the buyer incurs a loss.
So, both sellers and buyers fix the price and date in advance to avoid major losses and secure reasonable profits.
This is why futures trading is more active for products with high price volatility, like stocks or oil.
"Options are similar in concept. While futures involve committing to a future trade now, options only grant the right to trade, not the obligation."
Options have an expiration date.
The right to buy a product at a predetermined price by the expiration date is called a Call Option, while the right to sell it is called a Put Option.
"In futures, the trade is locked in regardless of price fluctuations by the expiration date. There's no escape. But with options, the trade may or may not happen depending on price changes."
Exercising the right to trade is entirely up to the buyer. If it's advantageous by the expiration date, they exercise the right; if not, they let it expire.
Thus, options with a higher probability of realization are priced higher, while those with lower probabilities are cheaper.
"When financial institutions or funds issue options, experts calculate probabilities and returns using various formulas. A mistake could lead to massive losses. One fascinating aspect of options is that a buyer's profit potential is unlimited while their loss is capped at the purchase price. For the issuer, profits are capped at the selling price, but losses can be unlimited."
For example, let's say there's a Put Option allowing you to sell a stock worth 2 million won at 1 million won on the expiration date.
Since the stock price halving is unlikely, the probability of exercising this Put Option is low, making the option price extremely cheap.
However, if the stock price rises to 2.5 million won by the expiration date, no sane person would sell it at 1 million won using the option.
Thus, the buyer forfeits their right, incurring a loss equal to the purchase price of the option, while the issuer gains the same amount.
Now let's consider the opposite scenario.
What if an extraordinary event causes the stock price to drop to 100,000 won by the expiration date?
The market price is 100,000 won per share, but the option holder can sell it for 1 million won.
This results in a profit of 900,000 won per share.
Naturally, the buyer exercises their right, and the issuer must honor it.
You might think the issuer just needs to pay 900,000 won per share, but what if the option price was 100 won?
From the issuer's perspective, they sold the right for 100 won but must pay 900,000 won—9,000 times the selling price. If the buyer bought options worth 1 billion won, the issuer would owe 9 trillion won.
Such events are rare, but…
Sang-yeop Senior gave a bitter smile.
"Good things rarely happen, but bad things always do—like 9/11 or the Lehman Brothers collapse."
When such crises occur, Put Option prices can skyrocket, forcing issuers to pay huge sums.
During the financial crisis, global investment banks suffered astronomical losses from derivatives they issued, leading many to bankruptcy or government bailouts.
"What happens if the issuer goes bankrupt?"
"Imagine you bought insurance for a landslide, but the insurance company gets buried first. What then?"
If the payer goes bankrupt, there's no way to recover the money.
To prevent such situations, regulations and margin systems exist, but in the worst-case scenario, there's no solution.
"Still, such events are extremely rare, maybe once in a few years. Most of the time, brokerage firms and funds simply rake in small investors' money."
After Sang-yeop Senior finished the basic explanation, he shared more insights that only experienced options traders would know. I listened carefully, mentally noting the key points.
Hearing this directly helped clarify what I had only understood theoretically.
When Sang-yeop Senior was done, he asked me,
"I'd advise against dabbling in options, but what exactly are you planning to do?"
I debated giving a vague answer but decided to be honest. I didn't feel right lying to someone who was helping me.
"Seo-Sung Electronics."
"Call or Put?"
"Put."
He looked surprised.
"Why? The L6 is doing well after its launch."
"That L6 is about to be discontinued."
"What?"
I told him about Taek-gyu's phone exploding and the reports of similar incidents online.
Sang-yeop Senior seemed puzzled.
"That's it? No other basis?"
Of course, there was more—just not something I could explain here.
"I just think if the explosions keep happening, it'll get discontinued. It's not confirmed information."
He gave me a concerned look and warned,
"Be careful. One wrong move with options, and you could lose everything, like I did."
"Yes."
We left the restaurant, said our goodbyes, and parted ways.
Once Sang-yeop Senior was gone, we got into the car.
I asked Taek-gyu,
"You heard him. You could lose everything in one blow. Are you still in?"
He nodded and looked at me.
"Of course. What about you?"
I gave him a sly smile.
"Let's do it."
Investing and speculating are fundamentally different.
Generally, taking manageable risks is called investing, while taking unmanageable risks is called speculating.
But the line between the two is razor-thin.
The same action could be an investment for one person and speculation for another.
Buying barren land with debt is speculation.
But what if you know about upcoming urban development plans? If you know a new city will be built on that barren land?
We're in a similar situation.
No one knows if Seo-Sung Electronics' stock will rise or fall tomorrow, but we know the L6 will be discontinued.
It's not about luck; it's about certainty. With confidence, it's an investment, not speculation.
Taek-gyu summarized it simply:
"When I do it, it's an investment. When others do it, it's speculation, right?"
I nodded.
"That's the correct answer."
People oppose real estate speculation but consider their home purchases an investment, not speculation.
I thought about investment methods.
The easiest way was short-selling. The expected return was around 20%. Even if things went wrong, the loss would be limited to tens of percent. But the profits would also be capped.
On the other hand, buying Put Options could yield returns of several to tens of times the investment if the prediction was correct. However, in the worst case, the entire investment could be lost.
"Low risk, low return. High risk, high return."
The lower the risk, the lower the return; the higher the risk, the higher the return.
After much thought, I reached a conclusion.
"Let's buy about 70% in Put Options and short-sell the rest."
This way, we could avoid the worst-case scenario while slightly lowering the potential returns.
Seo-Sung Electronics' stock price, which hovered around 1.4 million won, had risen sharply after the L6 launch, reaching the 1.6 million won range.
The L6 had received rave reviews for its design and performance, outperforming competitors like the En-Phone. It also achieved over 40% higher global sales compared to its predecessor.
Analysts predicted record-breaking earnings for the next quarter, and brokerage firms raced to raise their target prices.
But stock prices often deviate from expectations because they reflect future value rather than present value.
In other words, the current stock price of Seo-Sung Electronics already included the anticipated profits from the L6.
What if the L6 were to be discontinued?
Both current and future profits would vanish.
Since the stock had risen over 10% since the L6's release, it would at least drop by that amount. Considering the losses from refunds, it could fall by over 20%.
Taek-gyu, browsing online, spoke up.
"There's another explosion."
"Let me see."
This time, the incident occurred in the U.S., not Korea. The problem was even more serious because it didn't happen during charging.
Seo-Sung Electronics announced that they would investigate and claimed all past explosions were due to external impacts. They suggested this case would likely be the same.
As the explosions continued in both Korea and overseas, foreign media began to take interest.
Time was running out.
Just a few years ago, South Korea ranked first in the world for derivatives trading volume.
Although that's no longer the case, the trading volume relative to market size still holds the top spot.
Daily options trading averages 500 billion won, and futures trading exceeds 1 trillion won.
At this point, it's hard
to tell if the stock market is a marketplace or a gambling den.
Even now, fierce battles rage in the futures and options markets between speculators hoping to strike it rich and issuers trying to rake in easy money.
I sat at the computer on behalf of Taek-gyu and logged into the home trading program.
There were various strike prices for Put Options. The higher the strike price, the more expensive the option, while lower strike prices were cheaper.
Out of the 13.8 billion won in our account, 800 million won was my money.
Although Taek-gyu wanted to invest all the funds himself, I felt the need to share the burden since we were in this together.
So I decided to contribute my 800 million won.
Click!
I typed away, buying Put Options for Seo-Sung Electronics.
Regardless of the strike price, if the stock didn't drop as expected, all these options would become worthless.
I wasn't sure if this was the right thing to do.
Shaking off my doubts, I continued typing. But as I kept buying, an unexpected problem arose.
"There's not much volume."
Derivatives are usually issued based on indices like KOSPI 200 or HSCEI. Options based on individual stocks are limited.
Seo-Sung Electronics was an exception due to its prominence, but there weren't many options that fit our criteria.
I clicked my tongue.
"I didn't consider this."
Even Sang-yeop Senior hadn't mentioned this issue.
In hindsight, it made sense. Sang-yeop Senior probably thought we were working with a few million to 100 million won at most.
He could never have imagined we had 13.8 billion won.
Seo-Sung Electronics accounts for 19% of the stock exchange's total market capitalization.
No matter how dependent South Korea is on conglomerates, a market cap exceeding 250 trillion won is astonishing.
In theory, if Seo-Sung's stock fell by 10%, the KOSPI index would drop by 2%.
"If it falls by 20%, the index drops by 4%?"
Given its weight, the L6's discontinuation would impact not only Seo-Sung but the broader market as well.
I decided to buy KOSPI 200 Put Options too. Luckily, there was no shortage of options based on the KOSPI 200.
Ding! Ding!
The notification sound kept chiming as contracts were executed. The cash balance dwindled while the options balance grew.
Out of 13.8 billion won, we poured 13 billion into buying Put Options and short-selling. The remaining cash balance was only 800 million.
"Why not use the rest?"
"Keep the 800 million for your living expenses."
Even in the worst-case scenario, 800 million would be enough to sustain us for a while.
It was too late to turn back now.
All we could do was wait for the outcome.