This is pretty basic but maybe useful to some small portion of the Slope community.
I’ve been trading options with money in a smallish account for about 11 years. It isn’t small because I have never made money, but because I routinely transfer profits over a certain dollar amount into another “leg” of our investments. I have a larger, conservatively invested account with my husband and I make decisions on it much less often. It is designed to grow slowly. My options trading account is for making money in a higher risk trade, generating income and hedging during downturns in the overall market, downturns large enough to be considered a bear market, or during a recession. It is a way to capitalize on movement up or down in a stock, even to enhance profit one makes on a long-term stock owned.
My options experience is not the only way to use options. What I have come to trade is what works for me in a narrow area of focus. It requires constant adjustment as markets evolve. My favorite week to trade when I began was options expiration week, especially Friday of that week. Weekly options has totally changed that market rhythm.
Trading options on any stock or ETF without an underlying edge would just be gambling for me. I use charts, moving averages, Stochastic , RSI, MACD, directional moving averages, and look at what I am trading on multiple time frames from Quarterly down to 5 minute charts. My trading is short-term using options so though I look at larger charts for directional guidance and look at 10 or 15 minute charts to see sudden changes, I base my options trade on a 30 or 60 minute chart generally and plan to stay in the trade intraday to several days. In times of increased volatility I do multiple trades a day but that is not the norm – merely opportunistic. I find using smaller charts too difficult to rapidly move in and out of options. I base my trades on market conditions and around stock or market events.
If you trade options you must be right quickly. You must develop the discipline to sell immediately when wrong, and to never add to a losing position by buying more options, averaging down or up. I trade options in front of events my research tells me moves a certain stock, and don’t trade options against market direction as unlike short sellers, I have time decay to consider. I never put more than 50% and usually much less at risk in any trading situation. I can build a trading account back from a 50% loss, and have done so. It is bad money management to keep adding cash from elsewhere to replenish a depleted trading account. Probably the least I have ever had in my account in the early days was $3000. With discipline, which includes moving profits to more conservative investment accounts after a certain dollar amount, you can build a substantial investment portfolio – in time. Brick by brick. With poor money management and poor discipline the financial and emotional crush can drive you from the market.
You cannot trade options in an IRA. If you keep at least $25,000. in your trading account with the brokers I have used you can recycle your money, buy and sell what would total more than $25,000. during the day. Less than $25,000. usually requires you to stop trading for the day once you have cycled through the cash balance you began the day with. I follow my own rules and I have never had stock “put” to me. Shopping for a broker with low per-trade prices matters if you do a large number of trades per day/month/year. Do the math. However, what has mattered to me is a brokerage that doesn’t freeze or shut down in volatile markets like 2008 or 2018. Keep your broker’s phone number for the trading desk where you can find it quickly.
Because options are valued on two things, intrinsic value and time value, you absolutely must have movement, preferably rapid movement to make money unless you are selling calls “naked” – without owning the underlying stock which is called a “covered call” – or selling puts “naked”. There are good uses for these but they do involve higher risk and possibility of greater loss.
Covered calls are probably the safest way to use options. You must buy stock in blocks of 100 shares to do covered calls as 1 option contract “covers” 100 shares of stock. If you own 500 shares of a stock you can then sell the 5 calls (the right to purchase stock from you). Selling the call gives you the bid price with the worst outcome that you are “called out of the stock” – made to sell – at any time, usually if the stock begins to fall again while at the same time you keep the money you were paid for the option. Only sell one month out in time or less, and one strike above the current stock price for covered calls. Do the math and calculate what gives you a 5-10% profit or more.
I buy puts and calls without owning underlying stock as that is what I have developed an edge to do. I have a defined and limited risk for loss. In previous days the Specialist making the market on the trading floor was rewarded by keeping the spread between the bid and the ask – the price an option is for sale and the price it costs to buy – but with the rise of the machines you are trading against institutions with a huge edge. I only trade very liquid stocks or ETFs (QQQ or SPY or IWM) with only a penny or so between the bid and the ask. You can make up a larger spread if you are holding an option for a longer time period, but you are also fighting time decay. I just choose not to.
That brings me to one of the most important things to know about options: time decay. If money is not an issue, buy the most time you can afford when you buy an option. Anything a year out in time or more is called a leap option. It is not an option I use. There are two ways to lose money on an option you have bought – the trade goes against you or time decay. Time decay is exponential, and makes trading weekly options tricky. The closer you are to expiration, the greater the time decay.
These are my personal option guidelines:
- As you do for any trade, know your time frame and objective, and honor your own rules.
- If a trade goes against you, because you have time decay working against you as well as loss of intrinsic value, exit the trade. Never double down. Better to begin again.
- If the trade does not move decisively, exit the trade. Time is a huge factor. Weekly options need to move immediately and in your direction and for me are a day trade.
- Weekly options need an immediate catalyst or volatility in order to move.
- Trading options when the $VIX is 10 or 12 makes it difficult to make money even if the trade goes in your direction.
- If I made 100% on an options trade when I first started trading I exited the trade. Sometimes the pressure of making a good profit was reason enough.
- I buy in the money calls and puts, usually one strike in the money (the strike price below the stock price for calls)
- Buying deeper in the money calls increases your profit exponentially, and is exponentially more expensive.
- To begin with, do not own options past mid-day Thursday before options expiration. The time decay -Thursday into Friday is exponential, and combined with a flat market or trade going against you can wipe out any profit, or the entire value of your option.
- I never hold options on a stock announcing earnings unless I am prepared to loose the entire amount. I would consider trading 10-15% of what I would normally risk on an options trade only.
- If I am worried about a trade to the point I have trouble sleeping, I am risking too much money.
- I look for catalysts: Split announcements (for trading after the initial pop), stock news, research showing what stocks rise into set events (pre-earnings run-ups, trade shows, Christmas shopping seasons, etc.)
- I find it much harder to trade options in the decreased volume and volatility of summer.
- Check your entry before you hit sell, and check again. It is easy to select puts instead of calls in which case you would sell immediately.
- Your first loss in options is usually your best loss. Do not stay in a losing trade.
- I don’t trade options on stocks without sufficient volume in addition to volatility.
- I use day limit orders only, or GTC limit orders which I enter only when I am ready to sell; I have reached my target. I never let the market give me its price.
- In a particularly volatile market, I sometimes enter a limit order for a price much higher than I ordinarily would which is sometimes filled if the market hits an “air pocket” or has a mini crash.
- I have my accounts and passwords known to another person who could exit my trades and protect my account in the event I became incapacitated or died.
The best trading is actually a little boring. Options trading is no different. I started my trading by doing paper trades. It isn’t the same as real trading, the fear of losing money can be a powerful motivator, but it is useful to practice options in the educational trading portion of your brokerage account if only to practice using option chains, etc., and see what the effect of time decay or in-the-money vs out-of-the-money option purchases are on your profits. If the market is moving and the underlying stock is moving but your option price/profit is not, you probably need to adjust your choice.