Option Strategies
Mindset of Making an Options Trade
Principles you need to know before you begin this journey
Considerations in Placing the Trade
- Volatility of the Market reflects premium
- Implied volatility or volatility rank of the stock reflects premium
- Strike width
- Strike expiration
- At the money, in the money, or out of the money
- Understand management strategies
- Profit goals
- A Long Call Diagonal Spread is constructed by purchasing a call far out in time, and selling a near term call on a further OTM strike to reduce cost basis. This trade has only two legs, but it gives the effect of a long vertical spread in terms of directionality, and a calendar spread in terms of its positive vega. This results in a bullish position that can benefit from an increase in implied volatility. A Long Call Diagonal Spread is usually used to replicate a covered call position.
Identify what kind of trader you want to be.
- Make a killing
- Casual earnings
- Safe and steady
Identify the strategies that you are comfortable with. Can you use these strategies to implement your trading mindset
Make a killing
- Buy and sell puts and calls – most aggressive
- Debit vertical spreads – aggressive
- Straddles
- Strangles
Casual Earnings
- Vertical call or put credit spreads
- Iron condors
- Iron butterflies
Safe and Steady
- Covered calls
- Covered puts
Trade ETFs
- Less volatile with less swings
- More frequent expirations
Trade actual stocks
- Can be significantly more volatile
- Need to consider earnings dates
- Need to consider distributions
- Need to consider whimsical events on part of company
Identify an underlying stock you want to trade
- Trade actual stocks
- Trade ETFs
- Best of you are already familiar with the behavior of the stock or ETF as they all have their own personalities
Consider the environment in terms of volatility
- Less volatile with less swings
- More frequent expirations
Strategy considerations if you are very sure about direction and strength of a stock move
- Buy a call or put for a debit
- Buy a straddle or a strangle for a debit
- If you are less than VERY sure, you will want to consider hedging your bet by placing a credit or debit spread strategy that will limit any potential losses keeping in mind that it also limits your profit potential.
Strategy considerations if you are less than VERY sure about direction and strength of a stock move
- Buy or Sell a credit spread
- Buy or Sell a iron butterfly or iron condor
- If you are less than VERY sure, you will want to consider hedging your bet by placing a credit or debit spread strategy that will limit any potential losses keeping in mind that it also limits your profit potential.
Support and Resistance
Fibonacci Retracements and Extensions
Candlestick Patterns
Moving Averages
MACD
- Can be significantly more volatile
- Need to consider earnings dates
TT Squeeze
- Can be significantly more volatile
- Need to consider earnings dates
Bollinger Bands
- Can be significantly more volatile
- Need to consider earnings dates
Kelner Funnels
- Can be significantly more volatile
- Need to consider earnings dates
MACD
- Can be significantly more volatile
- Need to consider earnings dates
MACD
- Can be significantly more volatile
- Need to consider earnings dates
TT Squeeze
- Can be significantly more volatile
- Need to consider earnings dates
Bollinger Bands
- Can be significantly more volatile
- Need to consider earnings dates
Kelner Funnels
- Can be significantly more volatile
- Need to consider earnings dates
Fibonacci Retracements and Extensions
- Can be significantly more volatile
- Need to consider earnings dates
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Determine the width of the strikes
The argument for shorter strike widths
- Shorter widths are easier adjust if the trade goes wrong
- Shorter widths have less extrinsic value and therefore become more profitable faster
The argument for wider strike widths
- Wider widths collect more premium.
- Recall that the profit from any credit spread is equal to the premium collected
What I like for Credit Spreads
- I like strike widths of about 3 -5 dollars that yield about 1 dollar or more in premium
- I like strike widths up to about 10 dollars if I am pretty sure about the direction and strength of the move.
Considerations for the month of expiration
The argument for distant expirations
- Distant expirations give you more time to get the stock direction and degree of move correct– but at the expense of increasing the extrinsic value of the option contract.
- Distant expirations carry more premium for option sellers to compensate for an increase extraneous risks such as war and politics
The argument for closer expirations
- More frequent trading
- Less extrinsic value in the option and therefore a faster runway to profit
- Option sellers benefit from an increase in the theta of the stock option. The value of the option ( remember you keep the premium ) decreases faster.
What I like
- I like 30-45 DTE for the most part
- I like same or next week expirations if I am sure of a direction and strength for quick hits. Keep the contract numbers small and spread with narrow ( narrow widths are easier to roll to another expiration if you get the trade wrong )
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Option Strategies
What I like
Principles you need to know before you begin this journey
- Most of the time, I like selling premium strategies
- Instead of setting up iron condors or butterflies, I like legging into trades
- I like buying 2 contracts at a time depending my confidence on the trade. I even leg into contracts
- I like credit spreads about 3-5 dollars wide as they are a lot easier to adjust and roll
- I like credit spreads about 10 dollars wide ( only in a further out expiration ) if I am very sure of the direction and strength of the move – as I am more comfortable with the increased risk and potential hassle of adjusting the trade.
- I like expirations that are 30-45 days out as it gives the stock a chance to get its head right
- I like 7-14 day out expirations for quick hits.
- I like buying or selling ITM or ATM options if I am confident of strength and direction. The premiums are higher and they carry less extrinsic value.
- I will close the contract with the goal of making 50% of the premium noting that I will close earlier if the trade is looking shaky. Or will close for more profit if there is still a lot of time left on a contract and the stock is moving steadily in my favor.
- I will close the contract early if the trade is looking shaky as it is better to have a small profit than a big ( or any ) loss. Take the proceeds and place a different bet.
Keys to understanding options
Indicators
Building Blocks
Greeks
Implied Volatility
The Mark