Most Profitable Options Strategy

With over 40 different variations on techniques to trade options, it is pretty hard to decide which is the most profitable options strategy. Most traders, be they day traders or option traders, try to develop a trading plan that will at minimum beat the broader stock market, and there are hundreds of opinions about which is the best approach. Option trading offers huge profit potential, and so is very attractive, but at the same time, many traders have lost very heavily when they launch into the world of optionsMost Profitable Options Strategy. There are plenty of forum posts that state how dangerous options trading can be, and how bad it is to trade derivatives. Sometimes it seems that the only people making any kind of profit are those that sell options trading advisory services via a newsletter or website, and even their results are often disappointing. So, this then leads to two questions: is options trading really profitable, and secondly, if so, what is the most profitable options strategy?

Is Options Trading Profitable?

The truth? Yes, it can be. The leverage potential provided by options, which gives you the right to control large blocks of stock, is significantly greater than the potential of simple stock trading. If you are able to harness the power of this leverage, you can make huge amounts of profit from fairly small moves in the underlying stock price. With other strategies, you can make money if the stock goes down, and you can use yet another strategy to make money in a stagnant market. The problem with some (but not all) of the strategies is that you can lose a lot of money very quickly. In fact, if you make the wrong play, you can lose 100% of your investment within a couple of hours!

What is the Most Profitable Options Strategy?

Most options traders are introduced to the very simple to understand, and easy to implement, concept of buying calls (for an ascending market) or buying puts (for a descending market). As well as being simple to understand and apply, these two strategies have the potential to make fierce profit gains. It is possible to make returns of 100% or better within a couple of days or even hours of making the trade. So, for sheer magnitude of profit, this can be the most profitable strategy. However, it is also highly possible to lose 100% of your investment just as quickly! Even though websites and advisory services who market this technique will show these kind of spectacular results occasionally, it is more often true that they usually gain less than 50% per trade, and they have a large percentage of trades that go wrong!Most profitable options strategy If you have one trade that loses 100%, you need at least five trades making 20% or more in order to recoup your investment. Very few traders are able to make these kinds of winners on a regular basis. The reason is that in order to be successful at this strategy, you need to have excellent technical analysis skills so that you can accurately predict a market move and the timing of the move. It is possible, but it requires years of experience and a raft of technical analysis tools that you can understand and use effectively.

Selling Puts and Credit Spreads

Two recent academic studies* have shown that the most consistently profitable strategies are selling puts or selling credit spreads. Although the absolute magnitude of profit is less than that from buying calls and puts, the profit is regular and consistent, in the range of 7-12% per month on the whole portfolio. The strategies are reasonably simple, requiring a very basic level of technical analysis, and the percentage of winners is much higher (80% or more, with the right trading plan). Overall, the most profitable options strategy is that of selling puts. It is a little limited, in that it works best in an upward market, although even selling ITM puts for very long term contracts (6 months out or more) can make excellent returns because of the effect of time decay, whichever way the market turns. Selling credit spreads takes advantage of both upward and downward trends in the market, and the margin requirements are smaller, making it easier for the smaller investor to start. Even Iron Condors (basically two opposite standing credit spreads) make good returns in a stagnant market.

In Conclusion..

When looking for the most profitable options strategy, do not look at the magnitude of profit. Rather, look at factors such as risk of loss, the technical analysis requirements, and the potential to develop a safe, reliable trading plan that generates regular monthly or even weekly income....and then leave it to the power of compounding!

*Academic References:
Doran, James S. and Fodor, Andy, Is There Money to Be Made Investing in Options? A Historical Perspective (December 8, 2006). Available at SSRN: http://ssrn.com/abstract=873639 or http://dx.doi.org/10.2139/ssrn.873639

AN ANALYSIS OF INDEX OPTION WRITING FOR LIQUID ENHANCED RISK-ADJUSTED RETURNS. January 2012. Asset Consulting Group.

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