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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:
(i)
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 and 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!
(ii)
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 and 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 with Momentum Trading.
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.
This is where my ACTIVE CREDIT SPREAD TRADING concept kicks in. While I average about 15-18% 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,
and 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.
(iii)
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 or technical
indicators.
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.
(iv) 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 identify a trend (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 can sometimes get up to 70% profit
in a month.
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.
Return from Trading Strategies to the Home Page
Move on from Trading Strategies to the first step in developing your strategy: analysing a trend
Or: Have a look at what Options are all about
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