Option Trader: Raw
February 10, 2016
Hindsight is always handy but lessons learned help solidify what is known now after a challenge. Hopefully. What follows are lessons I’ve learned along the way as an option trader since…I think around 2012. This is a follow up to my $500 Trading Challenge post and will be updated as I learn more. Yeah for those looking for hindsight.
Have A Trading Plan And Rules
A trading plan defines a strategy, what you will trade, and how. The lessons learned will probably inspire some rules to follow as a trading journey marches forward.
My plan includes trading before earnings releases (ER), options with X amount of volume, and with cash and margin trading accounts. My rules are:
- Do not trade more than 20% in a single trade
- Do not hold a trade through ER
- Have the time available to exit a trade
- Trade stocks and/or options per technical analysis of overbought or oversold
Don’t Trade More Than X% Of Portfolio Value
This lesson is more about investment preservation than diversification to limit loss. Every trader loses at some point. If a trader is trading 50% or more of their portfolio value in a single trade then it’s only a matter of time until they lose at least 50% of their account. This kind of lose is devastating to recover from.
Holding Through ER Is Nothing But Gambling
Flip a coin and you may be more successful at trading through ER announcement than tons of research, experience, and paid service recommendation.
I’ve been an accountant for years and earned my MBA. I know financial statement analysis, how to look at ER history, and to research company and macro news. I did a research study in my article below.
Day Trade Weekly Options
Weekly options are those options with expiration not in the third week of the month. Option volume is generally lower and these option traders are high risk traders looking for fast gains.
Knowing option Greeks, option statistics about many things, is paramount because if a low delta, low gamma, and high theta are staring at you with one day to expiration you may just be looking to throw your trade value away.
This lesson holds true for monthly options about to expire this week as well.
Know Technical Analysis
Technical analysis, also called chart analysis, is a scientific method for trading. Many liken chart analysis to tea leaf reading but once the many indicators and overlays are known it becomes clear that traders before us who spent the time developing specific chart analysis actually were on to something. Millions of traders utilize chart analysis each day to determine better entry and exits.
Volume and price history are important chart indicators but are just the beginning.
Want to know what the majority of traders sentiment is towards a stock or underlying option? Chart analysis gives you the historic tools to give the answer. See my article below to get started with technical analysis.
Know Option Greeks
What are option Greeks? Please check out my article for a start.
Better gains and losses can be minimized when Greeks are researched in advance.
Trade At Trend Change
Trading at a trend change means anticipating the stock or option buyer or seller sentiment change. Which one is leading and is that group about to change their minds. It’s the point where a new group dominates that large gains start to appear. It’s not when $AAPL has been uptrending for six months and posts a new anticipated iPhone teaser. Its when something unknown or unexpected occurs.
As a speculative option trader high risk is already a part of the strategy. Sure, we could trade options that will expire six months from now and just collect the 5–20% gain after months of waiting. I suspect most speculative option traders aren’t using a long-term option hold strategy as their main strategy but more as a protect capital and profits strategy. No, our trading base is looking for 50–200% gains daily or weekly. Being in a trade before a trend change gives that gain potential.
Trading Fees Hurt
After a month of options trading with my $500 account challenge I’ve paid $500 in trading fees. At 5–7 trades a week a trader can see about 25 trades a month. At $10.75-$12.50 per buy and sell of an option trade a low account value trader can see $500/month in trading fees. This is one important factor that new traders don’t account for.
To stay within a 20% of account value per trade limit a trader can make $100 trades. At $21.50+ a trade round trip the prospects of a trade gain are cut by 22% at the entry. The bonus loss-> gain table below shows how much gain a trader needs to recoup a loss. A 22% trading fee is like a starting point loss, and the trader would need to gain about 30% to break even. The odds are against the new trader for sure.
Have The Time To Trade
Time is money when trading options. A trader never knows the exact moment a trend will change causing gains to fade away. If the trade isn’t being monitored, such as through chart viewing, setting a trading alert, or getting a text from those watching, then the trade can become a loser unexpectedly.
Setting a stop loss within a trading platform can aid in reducing unexpected losses. The % or value at which to set a stop loss is debatable but here’s a loss table that will aid in recognizing how much gains are required to recover from a loss %.
