It’s back-to-school season for kids – and back to the markets for many adults. Now’s a great chance to reform bad trading habits and kick off the return of “trading season” right. In this post Brian Overby outlines his top 5 options trading tips for back-to-school traders. Welcome back to the markets, folks! Of course, many of you didn’t stray far away – but for many individual investors, September marks the time when they log back into their portfolios, fire up the watch lists and start considering their next profitable trading move.
Whether you’re diving back in after months or just a few hours, here are my top 5 golden rules for smarter “back-to-school” trading:
1. Have a trading plan – and stick to it. Enter every options trade with a clearly targeted exit and a Plan B should your forecast not prove correct. That includes factoring in the possibility of early exercise and assignment, an ugly surprise to many newer traders.
2. Stop buying out-of-the-money options just because they’re cheap. An option is usually cheap for a reason: because the move it requires to become profitable is a huge long shot.
Heeding this resolution on options with large implied volatility (IV) has a bonus benefit – it can help you avoid the dreaded volatility crunch.
3. Steer clear of illiquid options. Options with wide bid-ask spreads are tempting when you like an underlying stock – but it’s tough to exit these positions, particularly if the trade goes south on you. Why make yourself crazy?
Look for open interest (OI) that’s at LEAST equal to 40 times the number of contracts you want to trade (10 lot means 400 OI). About 80% of the volume in the options market occurs in about 30 underlyings.
4. Stop “doubling down”. When an option trade moves against you, it’s tempting to compromise your risk tolerance– but think again before making any previously unthinkable moves. Options are a decaying asset -- which means a“double up to catch up” approach, popular among stock traders, has very different implications for options trades.
Ask yourself this: would you put on this trade now if you didn’t already have a losing position in it? If the answer is no, sometimes it’s best to close the trade, cut your losses and save your capital for a different opportunity that DOES make sense now.
5. Stay ready to buy back short options early. If your short option gets really out-of-the-money and you can buy it back to take the risk off the table profitably, then go for it. You can be burned by being cheap here.
6. Keep on learning! As our CEO Don (aka “BigDog”) often points out, options offer possibilities for profit in up, down, sideways AND volatile markets – but only if you’re educated on the subject. If your trading strategies aren’t working in these market conditions, it may be time to change things up.
TradeKing’s Learning Center and our many educational blogs can help you squeeze in a little options education every day. I can’t think of a better, or more potentially profitable, back-to-school resolution than that!
Regards,
Brian Overby
TradeKing's Options Guy
www.tradeking.com
[Image: Back to School (Part II) by Mathieu on Flickr]
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options available at http://www.tradeking.com/ODD.
Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.
Supporting documentation for any claims made in this post will be supplied upon request. Send a private message to The Options Guy using the link below the profile image.
TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice.
(c) TradeKing, Member FINRA, SIPC. http://www.tradeking.com