What Is A Lottery Ticket Trade?

For better or for worse, stock trading is often compared to gambling due to the uncertain outcomes and the financial risk involved. While most long-term investors are looking for any way to reduce risk in their portfolios, other traders enjoy the thrill of the big win, even if it means a loss or two in the meantime.

Some traders are always on the lookout for what they call “lottery ticket” trades. When you buy a lottery ticket, you are making a very small bet on a very unlikely outcome with a huge payout. The same idea holds true for lottery ticket stock trades.

For example, consider a biotech stock with only a single cancer drug candidate in the pre-clinical phase. These biotech stocks typically burn through a lot of cash, and a pre-clinical drug candidate has not even begun human testing yet.

However, if the drug ends up curing cancer, it would be worth billions of dollars. That outcome is extremely unlikely, but traders might make a “lottery ticket” bet by investing 0.1 percent of their portfolio. Much like buying a lottery ticket, they know the odds of that investment paying off are extremely low. But you can’t win if you don’t play.

Case In Point

Some traders have been calling drug stock Ophthotech Corp OPHT a lottery ticket trade in recent weeks.

Traders can also make lottery ticket trades on blue chip stocks as well. Earnings season is typically one of the most volatile times of the year for many stocks. Traders that believe a company like Facebook Inc FB had a blowout quarter might buy call options that are way out of the money ahead of the company’s earnings report. These options might expire worthless if the stock gains 15 percent or less during earnings week. But in the unlikely scenario that the stock jumps 20 percent, the calls could deliver 400-500 percent gains.

Speculation can be a fun and rewarding part of a trading strategy, as long as traders are aware of the risks and only allocate a small portion of any portfolio to pure speculation. Otherwise, you might as well just take your investment portfolio to Vegas.