How To Turn A Little Money Into A Fortune With Proven And Easy Options Strategies
Volatility Drives Success In Options Trading
Schaeffer's Investment Research, Contributor FORBES MAGAZINE
By: Rocky White
(Image credit: Getty Images via @daylife)
Established large-cap companies typically have very low implied volatilities. Their options are therefore often priced cheaper than options on other stocks, which in turn means a smaller stock move is required to turn a decent profit in the options. While stocks that have high implied volatilities need to make a bigger move for a similar profit, the chance of that big move is considered to be much higher.
This is the trade-off every option buyer must consider. On one hand are low-priced options that can profit handsomely on a relatively small move in the underlying. On the other are high-priced options on stocks that need to make a sizable move for the option to profit, but the potential for that sizable move is greater. In the analysis below, I take a look to determine which strategy would have been more profitable so far in 2012.
Low Implieds vs. High Implieds:
One way to measure the extent by which options are mispriced is to look at an equity’s straddle returns. A long straddle is a volatility play that combines a long call and a long put with the same expiration date and strike price. This strategy makes money when the stock moves enough in either direction to overcome both premiums.
TOP 10 TRAITS OF SUCCESSFUL OPTION TRADERS
They Are Properly Capitalized
– A very common mistake for beginner traders is not being properly
capitalized. Beginners see the power of leverage option trading offers
and think they can turn $2,000 into $20,000 in a matter of weeks. Before
they know it, a couple of losing trades have completely wiped out their
capital. I must admit I was also guilty of this. I was living in Grand
Cayman and had just started options trading. I think in my first 6
months I broke just about every trading rule possible. I had a couple of
small positions in the Australian stock market, one a utilities company
and the other a REIT (real estate investment trust). Both of these
positions had a low beta, meaning that the stocks did not move as much
as the general market. So, through lack of knowledge and understanding I
thought I would sell some call options on the main ASX index to hedge
and protect my long positions. I obviously didn’t understand my net
exposure was now hugely short as the short calls easily outweighed my
stock holdings. Sure enough the market rallied, I refused to admit my
mistake and take my losses and hoped and prayed that the position would
come back my way. Next thing you know my capital has been completely
wiped out and I had to send money via Western Union and have my brother
deposit the money in my account the next day. Not a great experience for
me, but one that I certainly learnt from!
They Have A Low Tolerance For Risk
– Another important aspect of successful options trading is having a
low tolerance for risk. The best options traders will only trade when
there is a low risk high reward scenario. They want to have the odds
skewed in their favor as far as possible. The best option traders will
not try to hit home runs with every trade.
They Trade Only When The Market Provides An Opportunity
– One quality all great traders have is patience. Successful investors
will only enter into trades when the odds are stacked in their favor.
They would much rather be the house rather than the average guy on the
street trying to win big. They are focused on the bigger picture and are
willing to wait and have the patience to only trade when the right
opportunity presents itself. Some of the best traders often talk about
sitting idle and just watching the markets, waiting for the perfect time
to make a trade. Amateur investors find it very hard to not trade and
are captivated by all the red and green numbers on their screen and feel
like they are missing out on the action. Can you think of times in your
trading when you have experienced this? Are you able to sit on the
sidelines and just watch the market without jumping in?Knowing what cycle the market is in, is key to knowing when to trade and which trades to make. The best resource if have found for knowing what cycle the market is in is Investor’s Business Daily. Each day they publish a Big Picture article which states whether the market is in a confirmed uptrend, the uptrend is under pressure or if he market is in correction. I have found them to be incredibly insightful and you would do well to follow their advice. Their advice is to only buy strong stocks when the market is in a confirmed uptrend and this has been a time tested method for market outperformance. While it’s still possible to make money on the long side while the market is in correction, the odds are stacked against you and you would only want to be buying leading stocks such as those in the IBD 100.
They Have A Trading Plan – Before opening an account, everyone should have a trading plan. This shouldn’t just be something in your head either, you need to write it down! By writing it down, it is clearly defined and you can refer back to it at any time. It will also be more real if you write it down and you’ll be much more likely to stick to it. Like anything in life, in order to be successful you need to have a plan and think things through rather than just flying by the seat of your pants. When I first started trading I would just place random trades based on how I was feeling at the time. I’d put on a bull call spread, then I’d try shorting stocks I thought were over valued and then I’d be making volatility trades. Needless to say I was not very successful during this time. While some of my trades were winners it was like I was taking 1 step forward and 2 steps back. All the great traders have a clearly defined trading plan. This is crucial to your success as a beginner options trader.
They Have A Risk Management Plan
– Only trade what you can afford, don’t risk money you can’t afford to
lose. Trade defensively, rather than think of what you can make, every
time you make a trade you should be thinking about the worst case
scenario. What could you lose and how you are going to handle the
position if things go badly? Beginner traders have trouble getting a
handle on how much to risk on each trade. When starting out you do not
want to have 90% of your capital tied up in one trade. One thing for
beginner traders to consider is to split your trading capital in half,
place half in an interest bearing account and use the rest to trade.
This way, no matter what happens, you will never lose all of your
capital. Another good risk management rule is to set a fixed percentage
of you capital as your risk per trade. A common method would be to set
5% as the maximum capital to risk per trade, but for beginners you could
even make that lower. Once a trade is placed you need to continue to
monitor risk levels, you can’t just have a set and forget policy, you
have to stay on top of your positions and your total portfolio risk.
Having a risk management plan is crucial to success as a trader and
something that should be done before you start trading. Everyone wants
to make a great trade and make lots of money, but you should never take
risk management too lightly. What risk management rules fo you have in
your trading plan?
They Can Control Emotions
– Options trading is an incredibly emotional journey and one that you
cannot fully appreciate until you have your own hard earned money on the
line. The best traders are able to control their emotions not just when
times are bad, but probably even more importantly when times are good.
In my experience, and I’m sure this is the same for most traders
starting out, some of my biggest losses have come when my confidence has
been high. The best traders can keep their ego out of the equation and
are able to stay grounded even in the midst of tremendous winning
streaks. Also, when one of their trades turns out to be a loser, they
are able to admit they were wrong and close out the trade. Great traders
never get attached to a trade or a particular stock. A bad trade could
turn out to be ok, but sticking to your pre-defined trading rules is
crucial. You can be 100% right on a particular trade, but you also need
to have the right timing. If your timing is off and your trade breaks
your stop-loss you should always stick to your trading rules and keep
your emotions out of it.They Are Incredibly Disciplined – Successful option trading takes a great deal of discipline. Beginner option traders may find it incredibly difficult to just sit and wait for a good opportunity to trade. Waiting for the right opportunities may mean you don’t trade for a while, but trading out of boredom or excitement is one of the worst things you can do.
Having a money management and a risk management plan is one thing, but in order to be a successful trader, you need to have the discipline to stick to it. You also need discipline to stick to the types of trades you are successful with and not start trading strategies that you are not an expert in.
They Are Focused – For beginner options traders it is very easy to get carried away and get excited by all the green P&L numbers on their account statement. Keeping a level head is essential. Staying focused can also be hard when there is so much news on the markets and so many experts, each with a different opinion. The most important thing is to stay focused on your goals, your trading strategy and your rules. Don’t try to copy someone else’s trades or go against your trading rules just because of something Jim Cramer said. Get to know yourself as a trader as well, I have had a few periods when I wasn’t focused and that led to some big losses. I now can recognize those periods and I know those are the times when I really need to refocus my energies and review my trading plan. If you find yourself losing focus, or getting too distracted and stressed with everything going on, it can be a wise move to close out all of your positions and take break for a while. Sometimes that is the best medicine and will allow you to come back with a clear head, more relaxed and more focused.
They Are Committed – Options trading takes a great deal of commitment. Any time you have your hard earned money at risk, you should be trying to get the most out of your investment strategies and controlling your risk. You need to be on top of your game all the time. Any time you stop paying attention to the market, you will get burned. Not only do you need to keep an eye on your trading performance, you need to be staying abreast of the current news, market cycles and investment outlook
TOP 10 TRAITS OF SUCCESSFUL OPTION TRADERS
They Are Properly Capitalized
– A very common mistake for beginner traders is not being properly
capitalized. Beginners see the power of leverage option trading offers
and think they can turn $2,000 into $20,000 in a matter of weeks. Before
they know it, a couple of losing trades have completely wiped out their
capital. I must admit I was also guilty of this. I was living in Grand
Cayman and had just started options trading. I think in my first 6
months I broke just about every trading rule possible. I had a couple of
small positions in the Australian stock market, one a utilities company
and the other a REIT (real estate investment trust). Both of these
positions had a low beta, meaning that the stocks did not move as much
as the general market. So, through lack of knowledge and understanding I
thought I would sell some call options on the main ASX index to hedge
and protect my long positions. I obviously didn’t understand my net
exposure was now hugely short as the short calls easily outweighed my
stock holdings. Sure enough the market rallied, I refused to admit my
mistake and take my losses and hoped and prayed that the position would
come back my way. Next thing you know my capital has been completely
wiped out and I had to send money via Western Union and have my brother
deposit the money in my account the next day. Not a great experience for
me, but one that I certainly learnt from!
They Have A Low Tolerance For Risk
– Another important aspect of successful options trading is having a
low tolerance for risk. The best options traders will only trade when
there is a low risk high reward scenario. They want to have the odds
skewed in their favor as far as possible. The best option traders will
not try to hit home runs with every trade.
They Trade Only When The Market Provides An Opportunity
– One quality all great traders have is patience. Successful investors
will only enter into trades when the odds are stacked in their favor.
They would much rather be the house rather than the average guy on the
street trying to win big. They are focused on the bigger picture and are
willing to wait and have the patience to only trade when the right
opportunity presents itself. Some of the best traders often talk about
sitting idle and just watching the markets, waiting for the perfect time
to make a trade. Amateur investors find it very hard to not trade and
are captivated by all the red and green numbers on their screen and feel
like they are missing out on the action. Can you think of times in your
trading when you have experienced this? Are you able to sit on the
sidelines and just watch the market without jumping in?Knowing what cycle the market is in, is key to knowing when to trade and which trades to make. The best resource if have found for knowing what cycle the market is in is Investor’s Business Daily. Each day they publish a Big Picture article which states whether the market is in a confirmed uptrend, the uptrend is under pressure or if he market is in correction. I have found them to be incredibly insightful and you would do well to follow their advice. Their advice is to only buy strong stocks when the market is in a confirmed uptrend and this has been a time tested method for market outperformance. While it’s still possible to make money on the long side while the market is in correction, the odds are stacked against you and you would only want to be buying leading stocks such as those in the IBD 100.
They Have A Trading Plan – Before opening an account, everyone should have a trading plan. This shouldn’t just be something in your head either, you need to write it down! By writing it down, it is clearly defined and you can refer back to it at any time. It will also be more real if you write it down and you’ll be much more likely to stick to it. Like anything in life, in order to be successful you need to have a plan and think things through rather than just flying by the seat of your pants. When I first started trading I would just place random trades based on how I was feeling at the time. I’d put on a bull call spread, then I’d try shorting stocks I thought were over valued and then I’d be making volatility trades. Needless to say I was not very successful during this time. While some of my trades were winners it was like I was taking 1 step forward and 2 steps back. All the great traders have a clearly defined trading plan. This is crucial to your success as a beginner options trader.
They Have A Risk Management Plan
– Only trade what you can afford, don’t risk money you can’t afford to
lose. Trade defensively, rather than think of what you can make, every
time you make a trade you should be thinking about the worst case
scenario. What could you lose and how you are going to handle the
position if things go badly? Beginner traders have trouble getting a
handle on how much to risk on each trade. When starting out you do not
want to have 90% of your capital tied up in one trade. One thing for
beginner traders to consider is to split your trading capital in half,
place half in an interest bearing account and use the rest to trade.
This way, no matter what happens, you will never lose all of your
capital. Another good risk management rule is to set a fixed percentage
of you capital as your risk per trade. A common method would be to set
5% as the maximum capital to risk per trade, but for beginners you could
even make that lower. Once a trade is placed you need to continue to
monitor risk levels, you can’t just have a set and forget policy, you
have to stay on top of your positions and your total portfolio risk.
Having a risk management plan is crucial to success as a trader and
something that should be done before you start trading. Everyone wants
to make a great trade and make lots of money, but you should never take
risk management too lightly. What risk management rules fo you have in
your trading plan?
They Can Control Emotions
– Options trading is an incredibly emotional journey and one that you
cannot fully appreciate until you have your own hard earned money on the
line. The best traders are able to control their emotions not just when
times are bad, but probably even more importantly when times are good.
In my experience, and I’m sure this is the same for most traders
starting out, some of my biggest losses have come when my confidence has
been high. The best traders can keep their ego out of the equation and
are able to stay grounded even in the midst of tremendous winning
streaks. Also, when one of their trades turns out to be a loser, they
are able to admit they were wrong and close out the trade. Great traders
never get attached to a trade or a particular stock. A bad trade could
turn out to be ok, but sticking to your pre-defined trading rules is
crucial. You can be 100% right on a particular trade, but you also need
to have the right timing. If your timing is off and your trade breaks
your stop-loss you should always stick to your trading rules and keep
your emotions out of it.They Are Incredibly Disciplined – Successful option trading takes a great deal of discipline. Beginner option traders may find it incredibly difficult to just sit and wait for a good opportunity to trade. Waiting for the right opportunities may mean you don’t trade for a while, but trading out of boredom or excitement is one of the worst things you can do.
Having a money management and a risk management plan is one thing, but in order to be a successful trader, you need to have the discipline to stick to it. You also need discipline to stick to the types of trades you are successful with and not start trading strategies that you are not an expert in.
They Are Focused – For beginner options traders it is very easy to get carried away and get excited by all the green P&L numbers on their account statement. Keeping a level head is essential. Staying focused can also be hard when there is so much news on the markets and so many experts, each with a different opinion. The most important thing is to stay focused on your goals, your trading strategy and your rules. Don’t try to copy someone else’s trades or go against your trading rules just because of something Jim Cramer said. Get to know yourself as a trader as well, I have had a few periods when I wasn’t focused and that led to some big losses. I now can recognize those periods and I know those are the times when I really need to refocus my energies and review my trading plan. If you find yourself losing focus, or getting too distracted and stressed with everything going on, it can be a wise move to close out all of your positions and take break for a while. Sometimes that is the best medicine and will allow you to come back with a clear head, more relaxed and more focused.
They Are Committed – Options trading takes a great deal of commitment. Any time you have your hard earned money at risk, you should be trying to get the most out of your investment strategies and controlling your risk. You need to be on top of your game all the time. Any time you stop paying attention to the market, you will get burned. Not only do you need to keep an eye on your trading performance, you need to be staying abreast of the current news, market cycles and investment outlook
TOP 10 TRAITS OF SUCCESSFUL OPTION TRADERS
They Are Properly Capitalized
– A very common mistake for beginner traders is not being properly
capitalized. Beginners see the power of leverage option trading offers
and think they can turn $2,000 into $20,000 in a matter of weeks. Before
they know it, a couple of losing trades have completely wiped out their
capital. I must admit I was also guilty of this. I was living in Grand
Cayman and had just started options trading. I think in my first 6
months I broke just about every trading rule possible. I had a couple of
small positions in the Australian stock market, one a utilities company
and the other a REIT (real estate investment trust). Both of these
positions had a low beta, meaning that the stocks did not move as much
as the general market. So, through lack of knowledge and understanding I
thought I would sell some call options on the main ASX index to hedge
and protect my long positions. I obviously didn’t understand my net
exposure was now hugely short as the short calls easily outweighed my
stock holdings. Sure enough the market rallied, I refused to admit my
mistake and take my losses and hoped and prayed that the position would
come back my way. Next thing you know my capital has been completely
wiped out and I had to send money via Western Union and have my brother
deposit the money in my account the next day. Not a great experience for
me, but one that I certainly learnt from!
They Have A Low Tolerance For Risk
– Another important aspect of successful options trading is having a
low tolerance for risk. The best options traders will only trade when
there is a low risk high reward scenario. They want to have the odds
skewed in their favor as far as possible. The best option traders will
not try to hit home runs with every trade.
They Trade Only When The Market Provides An Opportunity
– One quality all great traders have is patience. Successful investors
will only enter into trades when the odds are stacked in their favor.
They would much rather be the house rather than the average guy on the
street trying to win big. They are focused on the bigger picture and are
willing to wait and have the patience to only trade when the right
opportunity presents itself. Some of the best traders often talk about
sitting idle and just watching the markets, waiting for the perfect time
to make a trade. Amateur investors find it very hard to not trade and
are captivated by all the red and green numbers on their screen and feel
like they are missing out on the action. Can you think of times in your
trading when you have experienced this? Are you able to sit on the
sidelines and just watch the market without jumping in?Knowing what cycle the market is in, is key to knowing when to trade and which trades to make. The best resource if have found for knowing what cycle the market is in is Investor’s Business Daily. Each day they publish a Big Picture article which states whether the market is in a confirmed uptrend, the uptrend is under pressure or if he market is in correction. I have found them to be incredibly insightful and you would do well to follow their advice. Their advice is to only buy strong stocks when the market is in a confirmed uptrend and this has been a time tested method for market outperformance. While it’s still possible to make money on the long side while the market is in correction, the odds are stacked against you and you would only want to be buying leading stocks such as those in the IBD 100.
They Have A Trading Plan – Before opening an account, everyone should have a trading plan. This shouldn’t just be something in your head either, you need to write it down! By writing it down, it is clearly defined and you can refer back to it at any time. It will also be more real if you write it down and you’ll be much more likely to stick to it. Like anything in life, in order to be successful you need to have a plan and think things through rather than just flying by the seat of your pants. When I first started trading I would just place random trades based on how I was feeling at the time. I’d put on a bull call spread, then I’d try shorting stocks I thought were over valued and then I’d be making volatility trades. Needless to say I was not very successful during this time. While some of my trades were winners it was like I was taking 1 step forward and 2 steps back. All the great traders have a clearly defined trading plan. This is crucial to your success as a beginner options trader.
They Have A Risk Management Plan
– Only trade what you can afford, don’t risk money you can’t afford to
lose. Trade defensively, rather than think of what you can make, every
time you make a trade you should be thinking about the worst case
scenario. What could you lose and how you are going to handle the
position if things go badly? Beginner traders have trouble getting a
handle on how much to risk on each trade. When starting out you do not
want to have 90% of your capital tied up in one trade. One thing for
beginner traders to consider is to split your trading capital in half,
place half in an interest bearing account and use the rest to trade.
This way, no matter what happens, you will never lose all of your
capital. Another good risk management rule is to set a fixed percentage
of you capital as your risk per trade. A common method would be to set
5% as the maximum capital to risk per trade, but for beginners you could
even make that lower. Once a trade is placed you need to continue to
monitor risk levels, you can’t just have a set and forget policy, you
have to stay on top of your positions and your total portfolio risk.
Having a risk management plan is crucial to success as a trader and
something that should be done before you start trading. Everyone wants
to make a great trade and make lots of money, but you should never take
risk management too lightly. What risk management rules fo you have in
your trading plan?
They Can Control Emotions
– Options trading is an incredibly emotional journey and one that you
cannot fully appreciate until you have your own hard earned money on the
line. The best traders are able to control their emotions not just when
times are bad, but probably even more importantly when times are good.
In my experience, and I’m sure this is the same for most traders
starting out, some of my biggest losses have come when my confidence has
been high. The best traders can keep their ego out of the equation and
are able to stay grounded even in the midst of tremendous winning
streaks. Also, when one of their trades turns out to be a loser, they
are able to admit they were wrong and close out the trade. Great traders
never get attached to a trade or a particular stock. A bad trade could
turn out to be ok, but sticking to your pre-defined trading rules is
crucial. You can be 100% right on a particular trade, but you also need
to have the right timing. If your timing is off and your trade breaks
your stop-loss you should always stick to your trading rules and keep
your emotions out of it.They Are Incredibly Disciplined – Successful option trading takes a great deal of discipline. Beginner option traders may find it incredibly difficult to just sit and wait for a good opportunity to trade. Waiting for the right opportunities may mean you don’t trade for a while, but trading out of boredom or excitement is one of the worst things you can do.
Having a money management and a risk management plan is one thing, but in order to be a successful trader, you need to have the discipline to stick to it. You also need discipline to stick to the types of trades you are successful with and not start trading strategies that you are not an expert in.
They Are Focused – For beginner options traders it is very easy to get carried away and get excited by all the green P&L numbers on their account statement. Keeping a level head is essential. Staying focused can also be hard when there is so much news on the markets and so many experts, each with a different opinion. The most important thing is to stay focused on your goals, your trading strategy and your rules. Don’t try to copy someone else’s trades or go against your trading rules just because of something Jim Cramer said. Get to know yourself as a trader as well, I have had a few periods when I wasn’t focused and that led to some big losses. I now can recognize those periods and I know those are the times when I really need to refocus my energies and review my trading plan. If you find yourself losing focus, or getting too distracted and stressed with everything going on, it can be a wise move to close out all of your positions and take break for a while. Sometimes that is the best medicine and will allow you to come back with a clear head, more relaxed and more focused.
They Are Committed – Options trading takes a great deal of commitment. Any time you have your hard earned money at risk, you should be trying to get the most out of your investment strategies and controlling your risk. You need to be on top of your game all the time. Any time you stop paying attention to the market, you will get burned. Not only do you need to keep an eye on your trading performance, you need to be staying abreast of the current news, market cycles and investment outlook
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