COLUMN A, ONE
FROM COLUMN B...
The fun part is finding the
trade, right? Umm, maybe.
Ideally, though, this is a
pretty mechanical step.
You should have some
basic criteria, and technology can narrow down the
choices pretty quickly.
Consider picking your option contract month by looking at each one’s number of days until expiration. That
should have some relationship to the time frame of
your bias in step one.
If you’re looking to create positive time decay (i.e.
using short strategies), you may want to consider selling an option that has a comfortable probability of
expiring out of the money. So what’s comfortable for
you? Is it 50%, 60%, 70%? Thinkorswim’s option
chains make it easy to find the number you want, but
remember that probability is no guarantee. That’s
why you may want to hedge that short option with a
long option to help limit the potential loss—consider
either a further out-of-the-money option in the same
expiration to create a short vertical (aka “credit
spread”), or possibly the same strike price in a further
expiration month to create a calendar spread. Or
maybe two short
verticals to create
an iron condor. You
get the idea.
Make sure that
the option trade
you find conforms
to your outlook on
the stock. In other
words, you may not
want to have a
range-bound position for a stock you’re confidently
bullish on. And if you’re bearish on a stock, you likely
don’t want to put on a trade that would have a max
loss if the underlying drops. Consider using this as a
speed bump. This is the part that catches a lot of
rookie traders. Rookie: “You mean I shouldn’t buy an
out-of-the-money put calendar if I’m bullish on the
stock?” Veteran: “No.”
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over your trading career. For example, let’s say you’re
working to sell a vertical. Start with a limit price in the
middle of the bid/ask. Assuming the stock doesn’t
move much after a few minutes, you might want to
take your limit price down a little. No fill? Maybe take
it down another a little more. But if you’re not filled
then, and if you’re trading options with relatively high
open interest, you might want to walk away. No trade
is so good that you should give up too much slippage
to the market makers. If the market makers don’t want
to play, you can take your ball somewhere else. There
is always another trade.
KEEP YOUR FINGER
ON THE PULSE
This isn’t dollar-cost-aver-
aging with a mutual fund
that you hope will rise in
20 years. Traders tend to
monitor their positions and
most have an exit plan in
place. Will you get out of
the trade if it hits a certain
loss, or if it reaches some amount of profit? Or maybe
if the stock behaves in such a way as to make you
think your original bias is no longer valid? Be aware of
what the overall market is doing and how your specific
trades are faring.
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FIGURE 2: Every penny
counts when working a
trade. When using limit
orders properly, you’re
essentially haggling with
the market to get the best
price. For illustrative purposes only.
Again, the technology can make it easy. Real-time
streaming prices, live profit/loss calculations, single-click order entry, complex technical studies, alerts sent
to your mobile phone, sophisticated risk metrics—all
these tools are available in one platform to help you
turn the stumbles into steps. If you keep your first
trades small, you’ll potentially (and hopefully) only
get a stubbed toe, not a fracture. When in doubt, call
us. We can help you get up to speed!
Consider working your
order with a limit price
somewhere in between the
bid/ask spread. Sure, you
might not get filled, but
you don’t have to do an
opening trade at a price
you don’t want. No one’s
holding a gun to your head. Be patient. Saving pennies
in your order execution is a skill that you can develop.
And those pennies you save can make a big difference
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Options involve risk and are not suitable for all
investors. Supporting documentation for any claims,
comparison, statistics, or other technical data will be
supplied upon request. Professional access and fees differ. The information contained in this article is not
intended to be investment advice and is for illustrative
purposes only. Customers must consider all relevant
risk factors, including their own personal financial situations, before trading.