Comments Off on Opening the Option Trader’s Toolbox – Part 1
Opening the Option Trader’s Toolbox – Part 1
As a trader, you have more flexibility and freedom than you could imagine. The possibilities for creating a winning trade structure are endless, but if you don’t know the rules of the road then you’re going to get hurt. Many out there have set goals for themselves, work to achieve them and measure results. That is a great start. However, we don’t operate in a vacuum, and often times our targets need an adjustment. How do we do this?
What do you do with a mistake: recognize it, admit it, learn from it, forget it. -Dean Smith
Outcomes are ‘usually’ uncertain, unless you have some sort of crystal ball. So, when we put a play on we must be aware of the risk involved. More importantly, knowing our own risk tolerance levels. Is it reasonable to lay it all on the line and to go ‘all in’ with a binary result the only option? For the gambler, that may be true but for me I prefer to be more strategic. First, I will always leave my ego at the door. Trading is not a game of perfect.
We have to move our feet, and that requires doing SOMETHING. Don’t just sit there! If you have a nice 50% gain in an options play, what do you do? Better yet, what CAN you do? There are many things to make this work but you’ll have to think through it, and much of it is obvious. You can sell and take it all down for a nice win, never any shame in that – nobody ever went broke taking a profit. Rolling up to a higher strike and further out is an option, simultaneously taking some capital off the table. You could buy a put for protection, creating a strangle. Further, you can sell an upside call, capture some premium and create a vertical spread. You can do nothing and let it ride. You can sell half or part of it.
What if you’re sitting on a losing trader? A trade that is down 50%. Feels awful, doesn’t it? – especially when the outcome is worse than you expect. What’s your next move? There are repair strategies – like selling premium (calls or puts) to capture some of the cost, but often times a loser is just not worth holding onto. If you have rules in place to cut bait, then you just do it. There is no use leaving a trade open to look at a loser day after day until the option expires. I have even PAID the broker to get rid of a losing trade because I didn’t want to look at it any longer. Out of sight, out of mind. The next trade is the one that can make things better, always take the next trade.
Be decisive. A wrong decision is generally less disastrous than indecision. – Bernhard Langer
Understanding the potential outcomes of option trading is critical. This is a zero sum game, and if you’re on the wrong side of the fence then you’re a loser. However, we can become smarter, nimble, flexible and adaptable to certain situations – staying away from the ever present dangers. As a buyer of options we are fighting decay at all times and also have to be spot on target with direction. If you’re ready to make a move in the most optimum situation then you’re way ahead of the game.