Philosophy

Options Trading 101 - The Ultimate Beginners Guide To Options

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[headline_arial_medium_centered color=”#000000″]Trading Philosophy[/headline_arial_medium_centered]

With option income trading, it’s all about getting the passage of time to work in our favor. Time is on our side.

We all know that time decay speeds up towards expiry. Every man and his dog has seen the below image. A lot of people are lured in by this and start selling weekly options or other aggressive option selling strategies without understanding all the risks.

Options Time Decay

The most important thing when trading options for income is managing the risks. Whenever you enter a new trade, you should be thinking, “What can go wrong with this trade”. Most beginners look at a trade and think “If XYZ stock stays I this range, I’ll make 10%!!” which is completely ass backwards. ALWAYS KNOW WHAT YOUR RISK IS.

Another part of our philosophy is the KISS principle – Keep It Simple Stupid. Trading is hard enough without overcomplicating things. Why would you trade 20 individual iron condors, when you can get the same exposure trading 1 larger index iron condor? Could you imagine trying to close out 20 trades during a market panic? And then there’s the commission costs and the slippage. Yowser.

Having fewer trades means less time we have to spend monitoring positions and we don’t need to be stuck in front of a computer all day. With our strategies, you only need to check your trades once or twice per day.

Having fewer trades makes it far easier to monitor our Greeks, a key skill when it comes to option income trading. It is far easier to manage the Greeks on one underlying, rather than 20 and trying to Beta weight the deltas.

It’s our opinion that directional trades are a fools game. Sure, there is a time and a place for them and there are people out there who do it successfully.  But you will find their winners are interspersed with a lot of losers, and it is a lot more stressful than market neutral income trading via Theta decay.

With directional trades, or swing trading, not only do you have to be right on the direction of the stock, you also have to be right with your timing of the trade. It is very difficult to be consistently profitable using options for directional trades. Not only is it difficult, it’s time consuming to have to follow the trades and monitor the charts and stop losses.

Volatility provides fantastic opportunities for profit and should not be something that is feared, rather something that is relished. Income traders love seeing market selloffs and the resulting spikes in volatility as it bumps up option premiums and increases the cash we bring in to our accounts.

As a general rule, we will not trade individual stocks, particularly during an earnings month. Indexes are not as susceptible to huge gaps and are generally more stable than (some) stocks. Indexes are also European style which means they are cash settled and not subject to early assignment. They are also highly liquid allowing us to get in and out of positions quickly and with minimum slippage.

Have a Plan, Trade Your Plan, Review You Plan. That is our mantra. If you have a written down trading plan, you are already ahead of 80% of other traders out there. As the markets are constantly evolving, we feel it is ultra important to review our trading plans on a quarterly basis. We monitor, record and analyze all trades and evaluate areas for improvement.

We do not hold short options into expiry. Even if the underlying is 3% away from our short options we will close them out before expiry. A large gap on expiration day could leave us with no room to move and that is a risk we do not want to take.

The final part of our trading philosophy is that anyone can do this!  Options trading really is not rocket science. You don’t have to be some whiz at math, or technical analysis. Just start out by sticking to the basics and taking things slowly. Even the greatest traders had to start at the beginning.

 

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