How to match Stock Trading Strategies
with Option Trading Strategies

The magic of options is that there are so many different option trading strategies available for traders, each with differing levels of profit and of risk. In this section, you will learn about four different stock trading strategies, and how they can be applied when dealing options.  After comparing the different strategies, you will branch out to each strategy to learn exactly how to apply it to your portfolio. You can start with some minimal risk, profitable techniques, and then move on to more risky but highly profitable methods as you get more confident.

Firstly, which Strategy?

There are generally four different strategies employed by stock traders, each of which has implications when applied to options:

Position Trading

Traders buy a stock and hold it for long periods of time, based on good fundamentals of the company. They will often wait for a stock to reach really good value, and then watch for institutional or insider buying before making a move. As the stock price increases, they look out for other buyers to step in a move the price even further.

APPROPRIATE OPTION STRATEGY

  • BUYING CALLS & PUTS is NOT appropriate, because you pay large premiums for time value, most of which will be wiped out over time even as the stock gains in price. TIME DECAY is your enemy.
  • Selling COVERED CALLS each month in the option cycle on the stock you already own can significantly reduce the cost you paid for the stock in the first trade.Even if the stock goes down, you can still come out a winner!

Momentum or Trend trading

Once a stock has made clear move or breakout, the Momentum traders step in, and ride the stock up along a trend to its first major reversal. They hope to make shorter term profits from a rapid move in the price. Holding periods of six weeks to six months.

APPROPRIATE OPTION STRATEGY

  • BUYING CALLS & PUTS is NOT appropriate, because of the long term nature of the trade. You pay large premiums for time value, most of which will be wiped out over time even as the stock gains in price. TIME DECAY can be your enemy with Momentum Trading, although this effect can be minimised by trading LEAPS.
  • Selling CREDIT SPREADS is a good strategy, and in fact can be very profitable, because as you sell spreads on the opposite leg from the stock's direction of momentum, you can repeatedly buy back the spreads for minimum cost and sell another spread closer in. Or you can simply let the spread expire worthless, and you get to keep the profit. This is where my ACTIVE CREDIT SPREAD TRADING concept kicks in. While I average about 10-18% profit on a given stock each month, I have sometimes made 70% in a month as I ride the trend. Time Decay is your secret weapon for trading this strategy.
  • Selling NAKED PUTS is a good strategy, especially if your stock is in a positive trend, and it can be even more profitable than selling credit spreads. However, it leaves you a position of possibly having to buy a lot of stock if the trade goes against you, and so your broker requires you to have a lot of margin.

trading strategies

Swing Trading

Swing Traders buy and sell swings within a trend. Holding times are between 2 and ten days. A shorter term trading technique that is more dependent on the trend direction than it is on fundamentals. Technical indicators such as moving averages and candlestick patterns are important keys to the success of this type of trading.

APPROPRIATE OPTION STRATEGY

  • When you have mastered the skill of identifying reversals or swings within a trend, and have discovered how to plan an exit strategy, you will be able to start BUYING CALLS AND PUTS which will take you to real profits! With Swing Trading, holding times are short (2-10 days) and so you minimise the effect of your arch enemy, TIME DECAY.

Day Trading

Day traders focus on the many small moves that happen during the trading day, mainly shown up by candlestick patterns. This strategy has a broker's requirement of a minimum of $25,000 to qualify, which knocks out many beginners. It means a very long trading day, staring at computer screens. It also needs a deep and somewhat obsessive knowledge of myriads of technical indicators and patterns. Finally, it leads to ulcers, wrecked family life, nervous tension, bankruptcy, emotional trading decisions (especially when on a losing streak) and suicidal tendencies. Falls into my "Get a Life" category of careers - I would rather spend my time enjoying the money I make!

APPROPRIATE OPTION STRATEGY

  • Option trading is not appropriate with this strategy. Broker fees for options trading are quite high, and Day Traders end up paying vast sums to their brokers.

In Summary

If you own at least 100 units of a stock that is not particularly trending in any particular direction, sell COVERED CALLS each month in the option cycle. You can reduce the net price that you originally paid for the stock by between 5-12% each month.

If you have at least $1,000 in your account, and can do some basic Trend Analysis (using the method I will show you), you can easily SELL CREDIT SPREADS or SELL NAKED PUTS each month in the option cycle. If you use my Active Credit Spread Trading method, you will regularly get 10-15% profit each month, and may even get up to 70% profit in an exceptional month. NOTE: this is a really good strategy for beginners!

If you have mastered Swing Trading principles, especially the idea of planning entries and exits, you can start to BUY CALLS AND PUTS, and make phenomenal profits. NOTE: I strongly suggest that beginners to options do not start with this strategy!

Where to from here?

TOP TIP: Want to learn more? Here is an options trading video course that takes you step by step through real trades on the TOS trading platform. This course is excellent value for money.

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  • On this page you will learn about the four most important stock trading strategies, and which are the most appropriate option trading strategies to use with each.

    Keep in mind the important concept of TIME DECAY. This is one of the key factors in matching strategies.

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