Trade with a Margin of Error (by Andy Crowder)

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Okay, I think we all know my bias at this point. For those who don’t, it’s bearish.

I am not going to bother going into why I am bearish. Just read my posts from the last few weeks to truly understand why I am currently bearish.

So, I want to talk about something more important today – strategy. More specifically options strategies.

With options, you can control with precision, the amount of risk and type of risk you wish to take in any given trade in any situation.

One of my favorite strategies is selling vertical call/put spreads like in the Theta Driver Options Strategy.

Let me explain. And please understand I am keeping it simple for conceptual reasons. Once, you understand the basics we can really dig deep to understand how to apply risk-management.

For example, if a trader who only trades stocks or ETFs (not options) is bullish and buys a stock for $50 and at the same time I am able to sell a 44/42 vertical put spread (which is a strategy that bets the same underlying stock  will stay above $44 by options expiration) for $.25 ($1.75 is max risk). If stock rises to $53 by expiration the vertical put spread (let’s say 30 days), the stock trader makes $3 or 6%, but I would have made 14.2% on my spread.

If the stock stays at $50, the stock trader would have made absolutely nothing (while tying up capital) and I still would have made 14.2%.

If the stock drops to $44, the stock trader would have lost $6 or 12%, and I would have still made the 14.2% because the stock did not close below my the short strike price of $44.

As you can see my “probability of success” is greater, but I also cap my return at 14.2%. But, I don’t mind making that sacrifice because what are the chances that the stock will move up 14.2% or $7.10 over the same 30 days. And remember, if the stock does rise that quickly over a 30 period what is the likelihood that you actually going to keep the stock and take the prudent action by locking in gains. Of course, appropriate position-sizing is should always be the most important part when choosing to use otm credit spreads because you always want to keep a statistical edge.

The bottom line is that options get a bad rap, mostly because they are vastly misunderstood by most in the financial world. And if they are vastly misunderstood among financial professionals, how in the world should the retail trader or investor expect to learn about the effectiveness of options?

In many cases, with certain options strategies, the inherent greed of most investors deters them from capping their profits by using a spread strategy. Even if the chances of success is tenfold of what it would be if you bought a stock or even a long call.

That is not my game (even in the High-Probability, Mean -Reversion Options Strategy). I choose to hit a ton of singles and doubles with a high rate of success.