I'm very interested in hearing other peoples "rules" for trading
options. We can all learn from each other.
I have been quite successful trading options, and am fortunate
to know someone who really knows this stuff, and a broker who
is an avid option trader himself. They have taught me a lot.
Here are some of my option trading principles. Please forgive me if
I over do it a bit, but I'm really into this stuff. Also, please
do not take any of this as boasting or bragging, i just want to
help people make more sense out of option trading.
(Not necessarily in order of priority)
* I always buy in the money, with at least 60 days to expiration
* I never hold a call through an earnings announcement, unless
I'm doing a pure earnings play (reckless gambling, I call it!)
- It seems like stocks will drop faster on missed earnings than
they go up from earnings beating estimates.
* I won't fight the chart. The volatile stocks that we all play
are always testing resistance and support levels. I don't buy
in when they are in the middle. When I'm buying calls, I'll wait
until support is reached and held(hopefully). The opposite when
buying puts, waiting for resistance be reached and showing the
opportunity for the stock to settle back or major support levels
to fail.
* I have real time quotes and watch my positions closely.
- I am fortunate to have the luxury to monitor these
quotes at all times. If you can't, don't expect your
brokers to watch them. They may tell you they do, but
unless you're a major client, they won't. You may want
to put in your order to sell right after you buy the
contracts. This way, if the stock moves up during the
day and hits your target, you'll be out with your profit
automatically.
* When you want to sell, take the current bid. Don't play for a
little bit more.
- Let's say your option is 5 Bid to 5 1/2 Ask.
You place your order to sell at 5 and you are filled.
If you place your order to sell at 5 1/8, the specialist
sees you are there and may hold the bid at 5, even if the
ask moves up to 5 3/4. He/She may even move the bid down
to 4 7/8. They play "keep away" from you know who!
*If you are bailing out when the stock is moving away from
you in a hurry, place a market order. Don't worry if you
get taken for an extra 1/4(and you probably will), at least
you're out right now.
* Option specialists (traders, market makers, or whatever you call
them) have a license to steal. They move the bid/ask at their
discretion. Don't try to beat them, just pay their price.
* I don't get greedy. I determine my target price when I buy the
contracts. When/if I get there, I sell. I don't change my mind
and try to hold out for a bit more. Take your profit, say thanks,
and move on. If it goes higher later, forget it. Too many times
have I held out for more, only to see my entire profit waste away.
* Always know how much time premium is in your option.
- Time is the enemy.
Let's say you buy Apr 40 calls for 5 on a stock that is
at 42. You are paying $3 for time. If the stock locks dead on
42 until expiration, you will lose the $3, about 3/8 of a point
point per week. If you buy the Apr 45 calls on the
same stock for 2, you are paying $5 for the same time. Apr 50
calls for 5/8, you're now paying $8 5/8 for the same time!
That's over a point a week!
* I buy options on stocks over $30, preferably 50-70. It's more
likely to get a quick 3-4 point move on a $50 stock than on a $15.
Obviously, it's even easier on an $80 stock.
* Use a broker who knows a great deal about options, preferably one
who trades a lot of options themselves.
* Don't get hung up on percentage gains. Focus on the net profit
in dollars. I play 10-30 contracts for 1 or 2 points, and I'm out.
If I pay 2 and get 3, great. If I pay 8 and get 9, also great.
It's the same dollar gain. Yes, you have more on the table to
lose, but I also find it easier and quicker to get the 1 point
move on the higher contracts. On cheap contracts, the stock has
to move quite a bit for you to cover the ask and your commission
cost before giving your the 1 point NET gain.
* etc. etc. etc. .......
I am a pretty active trader. The AMER puts I sold yesterday were
probably my 15th trade this year. I held that for 2 days and made
4 points. I could have made 3 more points today, but I also could
have lost it. I also bought INTU calls last thursday and sold
monday for 2 points. Tuesday would have given me 4 more. Oh well.
Remember, options don't start trading until around 9:40. If the stock
opens away from you and the stock keeps moving, you're dead. You do
get the benefit from the options trading until 4:10, however. Often
times I wait to see where the stock closes, then get out right after
the close. A lot can happen in the last 5-10 minutes.
I hope this is helpful to everyone. Please do not hesitate to tell me
if I am erroring on any on this.
Best of luck.
-Bill Russell
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