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I noticed that we have had several posts lately concerning options.
Trading options can be as simple or as complicated as you want to
make it. It's nice if you understand the nuances of the "greeks"
but one CAN successfully trade options with only a few tools.
What follows is Walt's guide to successfull "blue collar" (simple)
options trading. After you finish reading these rules you
will say "Gee, sounds too simple to work!" Well, most of my income is
generated from trading futures, but I made more money last year
trading options, and these rules are what I followed.
:)
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The CIS Blue Collar Guide to Trading Options
BY
Walt Downs
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(Definitions of Option terminology are at the bottom of the article)
1. The trader must have an idea as to market direction, market/option
volatility, or prefferably, both.
2. If market/option volatility is low initiate positions with
outright calls or puts, or initiate option "straddles" for volatility
plays.
3. If market/option volatilty is high, use vertical option spreads.
to dampen volatilty damage to your position if the market doesn't move
right away.
4. Do not initiate "strangles" or naked writes. These strategies are
dangerous to option traders not willing to put in a lot of hours with
option pricing models.
Money Management:
1. Purchase options with 2 months to 3 months to expiration. Make
sure the front option month has at least 2 weeks to one month before
expiring, and try to make sure your position is liquidated before the
front option month expires. Otherwise, you will take a large "time
decay" hit when the option months "roll".
2. If an option gains 50% in value, remove half of your position, or
liquidate the position, and buy 1 OTM option just in case the market
keeps going.
3. If an option loses 50% of it's value, hold the option. 80% of the
time, the market will come back, and give you ONE opportunity to exit
this option at or near the price at which you purchased it. When the
option has recouped 75-100% of the original purchase price, EXIT THE
OPTION. If your initial market view was wrong, there is no sense
hanging out, and hoping the option will now move in your favor. Be
grateful that the market sees fit to give you your money back. :)
4. Trading Option Blocks: If you implement these strategies there
will be times when you have maybe 10 or 20 different option positions
in various markets. Make sure to view these as a combined block, as
well as individual trades. Every once in a while a "block" will have
a really good day: The winners gain more, and the losers gain back
some of what they lost. At times when you experience a block expansion
in value like this, I recommend liquidating the entire block, and taking
the windfall.
In Summation:
Learning the "Greeks" and implementing strategies with the aid and use
of an options model, will make you a more sophisticated and precise
trader, but you CAN get by with volatility and nothing else.
For more info on Option volatility, visit:
http://www.pmpublishing.com/volatility/index.html
Walt Downs
CIS Trading
http://www.cistrader.com
Definitions:
Strangle - An option strategy often entailing the SALE of two options
on either side of the current market price. Trade made on the assumption
that the market will continue to trade imbetween the two price levels,
enabling the trader to profit from both options. Example: Market at
10, Sell a 15 call and Sell a 5 put.
Straddle - the opposite of the strangle. With a market trading at 10,
the trader would Buy a 5 put and Buy a 15 call, looking for the market
to expand rapidly out of the trading range. For straight volatility
plays, with a market trading at 10, one would buy the 10 call and
Buy the 10 put.
Market/option Volatilty - Market volatility is usually defined as
expansion or contraction of price. Option volatility is usually defined
as implied (current) volatility versus historical volatility .
Naked Write - The SALE of an option without the benefit of any type
of "hedge" . i.e., the risk to the seller is unlimited.
Market Roll and Time Decay - Most of the value of an option that has
say, 3 months to expiration is "time-value". When a front option month
expires, the next month "rolls" to the front spot, and option models
become much more sensitive to the time decay. Often this causes a
sharp drop in the value of the options.
Vertical Spreads - If one is bullish, one buys a call, and Sells a
further out of the money call. This reduces the volatility of the
position, since the call that is sold will "balance" out the call
that is purchased. This strategy limits the possible profit of the
position to the difference between the strike prices.
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