Different Option Strategies Explained

TK All-Star posted on 02/23/12 at 03:13 PM



TradeKing All-Star Blogger Mark Wolfinger explains different option strategies with a client on the Trader Network!

Posted by
James MacK

I've been in and out of options for the last 3 years. I'm surprised I'm still here to be honest with you. I'm trying to see how those of you trade your options. Lately I've been in and out of one of the big ones on the market. Before the market opens I look at the pre market direction. I read some of the news and then let the market open. I watch the options fluctuate and then I decide what side of the market I want to be on for that period of time. The problem is I've been reluctant to pull the trigger and later find out that if I did I would of been fine as long as I got out at the retracement.

How do you get the nerves to pull the trigger?

Mark’s Response:

James,

You DO NOT want to pull the trigger. At least, not this trigger. There are better weapons at your disposal.

Options are simply not designed for shorter-term trades. Just look at the wide bid/ask spreads. We know that you may get a better fill than selling the bid and paying the ask price, but every time you trade, there is slippage. [Slippage is the difference between the expected price of a trade (bid/ask midpoint), and the execution price.] And that option slippage is much larger than stock trading slippage. For short-term traders, those differences can truly affect the profit/loss picture.

If that’s not enough, you are looking at the wrong data. Seeing pre-market direction, reading news, and watching options fluctuate tell you NOTHING about what you really want to know. You plan to trade options, not the underlying stocks!

Do you understand which strikes are best to buy? Do you recognize the futility of trading options that are far out of the money? Do you pay attention to implied volatility levels so that you can get a handle on whether you are paying a cheap or dear price for those options you plan to buy? Have you never noticed that calls often do not move as far as you expected them to move when the stock rallies?

Do you know that buying options is a very difficult game and that it takes a great deal of skill to come out ahead?

Did you ever consider alternative strategies, such as selling OTM put spreads when bullish? Or call spreads when bearish? I urge you to look at making this play – if you are willing to accept limited profits and if you plan to hold the trade for more than a few days. Your profit/loss ratio could be significantly higher compared with buying calls, and if you choose your strikes and position size with care (collecting sufficient cash when opening the trade, and not taking more risk than you are willing and able to take), you could do far better than you are doing now.

Your own experience over the past few years should tell you that something is wrong. It is not that you lack the courage to pull the trigger; it is that you are looking at the wrong weapon (trading strategy).

Mark D Wolfinger


Options involve risk and are not suitable for all investors. Click here to review the Characteristics and Risks of Standardized Options brochure before you begin trading options. Options investors may lose the entire amount of their investment in a relatively short period of time. Online trading has inherent risk due to system response and access times that may vary due to market conditions, system performance, and other factors. An investor should understand these and additional risks before trading. Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax professional prior to implementing these strategies. While Delta represents the consensus of the marketplace as to the theoretical price movement of the option relative to the underlying security, and Gamma represents the consensus of the marketplace as to the theoretical rate of change of Delta relative to the underlying security, there is no guarantee that these forecasts will be correct.

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Posted by TK All-Star on 02/23/12 at 03:13 PM

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