All Entries in the "Index Option Trading Strategy" Category
Futures – Can They Predict the Market?
Anything that can help us figure out which way the market is going to head is a good thing right? YES. And I use as many indicators as possible to give me helpful information, avoiding deep analytics as often as I can. I’m sure you all know or have observed, the market seems to make some of it’s most significant moves at the open and the close of the trading day. It has been said that the open of the market is determined by the amateurs and the close of the market is determined by the professional traders, and whether you subscribe to either of those ideas, the truth is, the market does move more at the open and at the close, for whatever reason.
The Truth About Buying Power
We all know about the need for buying power when we make our initial trades during the month. And we all love that our thinkorswim software recognizes that you can’t lose money on both the puts and the calls when establishing an iron condor, so in essence our second trade of the month is essentially free. The question there for needs to be asked, how my money or buying power should I hold in reserve?
Option Trading Strategies – Tips for Profitable Trading Part I
Option Trading Strategies – Tips For Profitable Trading
Most folks I talk to know about the stock market and have purchased a stock or two, many have a large portfolio of stocks, but confess they know little about stock options and why one would invest in them. Stock Option trading is a great way to invest in the stock market without having to invest in the underlying stock. Stock option trading comes with its own vocabulary and you would be wise to learn as much as you can before jumping in. A good reference for the basics is Understanding Options by Michael Sincere. My advice is to read as many books on option trading as you can get your hands on.
See my recommended Resource List located at the end of the article.
This article is going to assume you know the basics of stock option trading and talk specifically about tips that will help the novice to experienced trader make a profit from option trading.
TIP 1 – Educate your self. Read as much as you can, both on line and hard copy publications/books. See the resource list at the bottom of this article for some of my personal favorites. Take a class, online or real time. Get coaching. Some instructors also provide one on one or group coaching with their educational offerings. Prepare yourself, arm yourself with every thing you can to be ready to trade for profit. All new traders make mistakes, but you can greatly minimize errors with knowledge.
Tip 2 – Have a strategy. One of the biggest mistakes new traders make is to start trading without following a tried and true strategy.
Spend the time, energy and money to learn a good strategy that works for you. Implement a strategy that takes into account your risk tolerance, your time available to trade and your long term interest in trading. If you don’t think it’s fun, or can’t take the pressure, find another line of work.
The strategy I use has been tested for a number of years and works. It works in up markets and down markets. It works through a market crash. More importantly it works for me. The strategy I use guides me to know when to enter the market, when to exit, when to use profit lock and stop loss strategies. Learn more about my strategy.
Tip 3 - Have discipline. Now that you have chosen the strategy that works best for you and have invested the time and money to learn everything you can about the strategy, you have to stick to it. Most new traders get into trouble because they deviate from their strategy. I don’t know what it is about human nature that we find ourselves doing things we know we shouldn’t. Option Trading is not for everyone, psychology plays a huge roll in trader success. I have a good friend who also trades options using the strategy that I use. Early on in our trading he placed a trade that almost got him into trouble. He knew the strategy, but ignored it, just that one time because he felt as if he had done the analysis he needed to eliminate the risk and make just a tad bit more money. Fortunately for him, he is also very lucky, but one day his luck will run out if he doesn’t go back to basics and follow his strategy. Without fail. Which leads to my next tip.
Tip 4 – Don’t get greedy. The strategy I use nets me about 8 – 12% a month. Yes, that’s a month. Now let’s face it, I’ve got tons of other investments that I’d be happy making 8% a YEAR, much less a month. So if I can consistently get that rate of return, each and every month, do I really need to get greedy, take more risk and make more? There have been some months when I’ve made upward of 15%, but honestly, I can make 5% a month and be perfectly happy with that result. The point is, when the strategy is working, month after month, and you see that you could have made more money, taking a little more risk, month after month, resist the temptation to take that extra risk. Cause if you do, it will come back to bite you, hard. Just don’t do it… Want to learn more about my strategy? Click Here
Tip 5 – The abundance of really good option trading software link to option trading software post makes the process of placing trades easy and fast, without the need for human intervention. With the ease of use of on-line option trading software comes the frequency of errors when making trades. To ensure you understand how to use the software, read the users guide, Paper Trade (link to Papertrade post) first and create a checklist that you follow for each and every trade you make. I’ve been trading for a while now, and I still occasionally forget the very basics and miss something, placing an incorrect trade. I use ThinkorSwim as my trading software. www.thinkorswim.com. My checklist looks something like this and is posted in my office above my computer screen so I always reference it.
Items to Double Check For Every Trade
- Strike Prices
- Number of Contracts
- Net Profit From Trade
- Commissions Paid
- Percentage Profit From Trade
- Limit or Stop?
- Day or GTC Trade
Please send me your favorite reference sources and I’ll include them in my Resource List.
Resource List:
Understanding Options by Michael Sincere
Options Made Easy by Guy Cohen
The Bible of Options Strategies by Guy Cohen
The Rookies Guide to Options by Mark Wolfinger
Option Spread Strategies by Anthony Saliba
Trading for a Living by Alexander Elder
Want to learn more tips? Check out OPTION TRADING STRATEGIES – TIPS FOR PROFITABLE TRADING – PART II Click Here
Option Trading Strategies – Tips for Profitable Trading Part II
Option Trading Strategies – Tips for Profitable Trading Part II
If you missed the Option Trading Strategies – Tips for Profitable Trading Part I click here
Tip 6 – Analyze. Most option trading software provides a wealth of tools that assist the trader in analyzing positions and trades. I use ThinkorSwim software www.thinkorswim.com and have used their on-line tools and studies to help me make better decisions. I consult their charts and tools every day, taking advantage of the analysis and the information it provides. Learn more about analytics click here.
Tip 7 – Follow the news. I have a home office where I trade. I have a TV in my office which is always on, usually tuned to CNBC. I’m sure my family thinks I’m really watching the Food Network during the day, but not so. I watch the financial news during the day. I surf the internet for upcoming events that could effect the market, housing starts, job reports, earnings reports, etc. anything that could cause the market to react, favorably or not. The market also responds to non-financial news, particularly political news. Remember to keep your eye on what’s happening, in and out of the market.
Tip 8 – Paper Trade first. Most option trading software programs have the ability to paper trade or simulate the trading experience with paper money. ThinkorSwim sets you up with a Paper Trading account that allows you to fake trade with $100,000. Take advantage of it. I still use my paper trading account to try new strategies, indexes or option types that I haven’t traded before. Paper trading allows you to practice placing trades, learning how to use the software. One thing to take into consideration, paper trading simulates the market, it does a good job of helping you to understand how to use the software, but it is not 100% representative of how the market will react in live trading. One thing I have noticed about paper trading vs real trading is that trades execute much quicker in paper trading. Please keep in mind things that happen while paper trading are simulations, real trading is, well, REAL!
Tip 9 – Do paperwork! We all hate to do paperwork – okay there are the rare few who like it, but most of us would rather not bother. Here you have to bother! Create a process that works for you in recording your trade activity. I use a simple report that tracks all my trades. I go back to them often to help me plan my next trades. At the end of the trading period I simply print out my monthly statement and put it in a binder. I also have created an excel spreadsheet that I track profits and commissions on a monthly basis. At the end of the year, I print and send to my accountant. Easy, done, legal.
Tip 10 – Mastermind if you can. If you are not familiar with the concept to masterminding, Google it, there is a wealth of information on the subject available. I have a mastermind group of 6 people, we talk for about an hour once a week. Same day, same time, every week. We are all following essentially the same strategy, but that is not necessary. We share our thoughts on the market, our strategies, psychology, wins and losses. We learn from each other and it makes it really fun. Being on a mastermind group has given me so much more knowledge and confidence much faster than I could have gotten on my own. It has helped me make better decisions and has probably kept me out of trouble a time or two.
Bonus Tip – Have Fun. I don’t know about you, but I have had jobs that were, well, JOBS.. Not much fun, working for people I don’t like or respect, working with people I don’t like or respect, spending countless hours making money for someone else, doing something I’m tired of doing, yadda, yadda, you know the drill. Now I trade options for a living. I spend at most, an hour a day trading, most days I don’t trade at all, I just monitor my positions and do nothing. Fortunately for me, I live on the west coast so my day ends as 1pm when the market closes. I do what I want to do, pretty much when ever I want to do it, and I make money every month. I don’t have to sell anyone anything, I get to work my own hours, I carry an iphone with me loaded with a trading application (called iswim from ThinkorSwim) so I can monitor my positions and trade from anywhere. I have a community of option trading friends with which to share this journey with. If you are interested in finding out more about our community please visit us at www.optiontradingcommunity.com – comments and participation encouraged!
The Psychology of Option Trading
The Psychology of Trading – Some Thoughts Are the markets a zero-sum game? In a zero-sum game, winners make as much as losers lose. So you’d think that trading in the market is such a “game”. If I bet $10 the S & P will move 50 points up and you bet $10 that it will move down 50 points, one of us will win and one of us will lost. Zero-sum, right? Well think again. What people fail to realize is that trading on the markets is a minus-sum game because winners receive less than losers lose and the brokers and market makers chuckle all the way to the bank. Successful traders ignore the money Trading for a living appears to be deceptively easy. Most of us work from home, make our own hours, live where we choose to, and work for ourselves. I live on the west coast so the market closes at 1pm leaving me most of the day to do whatever I want. When a new trader makes winning trades, they feel like they are brilliant. A number of good trades in a row – invincible. Gaining confidence, he or she starts taking risks, deviates from the plan and before you know it loses everything. The focus is on the money, typical rookie mistake. Instead of focusing on the money, learn to trade well. Professional traders do not think about the money, they focus on the trade. If the trade is good, the money will follow. Successful traders keep learning, improving their skills to the point that the money doesn’t matter and at that point ceases to influence emotions. There are no “trading secrets” Amateur traders who lose money often blame it on their lack of knowing the “trading secrets”. A professional trader knows there are no secrets to trading. Successful traders are realists. They know what they can and cannot do. They trade with their eyes open, and they stay in tune with their reactions and their emotions. As soon as emotion enters into a trade, up goes the red flag. Journal = Success Amateur traders often repeat their mistakes, slapping their foreheads saying, oh yeah, I remember making the same mistake last week/month/year. Successful traders keep track of their trades, their strategies and their emotions while entering and exiting trades. I personally use a journal to keep track of all aspects of my trading. I capture when I place a trade and why I chose that particular time. I carefully document when I exit my trades or if I let them expire, why I did so. For new traders I suggest also keeping a record of your feelings, before and after placing a trade, during the time you hold a position and your reactions to movements in the market. Look for patterns, of success and failure. Trading is not for everyone and if you find yourself overly anxious, losing sleep or freaking out, another profession might be better for you. The big 3 In my opinion there are three basic components to successful trading: a sound psychology around trading, a good trading strategy, and money rules. You need the intellectual and emotional discipline to be a trader. Your emotions have a direct impact on the size of your account balance. You can have the best trading strategy in the world, but if your behavior is impacted by fear, greed or arrogance, your account balance will surely suffer. You need a trading strategy with a history of success and you must follow it, period. Many a novice trader learns a strategy, experiences success, gets over confident, tweaks the strategy “cause they know better” and loses. Just don’t do it! You need rules that determine when and at what position you enter and exit trades, when you stop your losses and take your profits. Mitigate your risk by diversification. Once again, you must have rules and of course you must follow them! To trade or not to trade Individual traders have a significant advantage over institutional traders. Institutional traders have to trade. They can’t sit on the sidelines during a volatile market move. Individual traders need patience. I fell into this trap my first month trading. After paper trading for a couple of months, I funded my account and instead of waiting until the right time to jump in, I couldn’t wait and made a bad trade. I lost money that month, but learned a valuable lesson. Trading for a living is a long-term endeavor. It’s okay to not trade if the situation dictates. Amateur traders get emotional about trading and lose their money. A sure sign that psychology is the key to success or failure trading. The crowd mentality Did you realize that the market is more often than not lead by the whim of the crowd rather than sound financial indicators? We’ve all heard stories about the maddening crowd mentality where people behave in ways they would never if acting alone. Please keep that in mind when trading. Develop sound trading strategies and stick with them. Listen to the news, and the financial “gurus” if you have to but don’t let them lead you astray from your strategy. Stick to your strategy and your money rules. I recently read something that I liked so much I’ll share it with you. Opening prices in the market are typically a reflection of the amateur traders perception of value. They read the paper, look at what happened the day before and most often trade early in the day. Professional traders trade against the amateurs; they unwind their positions during the day and trade the close. So if you want to know what the professionals think, look to the close.
Paper Trade First!
Most option trading software programs have the ability to paper trade or simulate the trading experience with paper money. ThinkorSwim, the software I use, sets you up with a Paper Trading account that allows you to fake trade with $100,000. Take advantage of it. The purpose for paper trading is not only to test out and learn how to implement your strategies, but also to learn how the software works. Most online trading software programs available today have a wealth of analysis and charting features. Learn what your software has to offer and use it. Most of the companies providing software also provide excellent user guides, online training and support. And the best part of all of this is it’s free. One caveat to the free software, it won’t tell you what or how to trade, identify hot stocks or provide you with a strategy. There are for a fee based software out there that do provide these.
One thing to take into consideration, paper trading simulates the market, it does a good job of helping you to understand how to use the software, but it is not 100% representative of how the market will react in live trading. One thing I have noticed about paper trading vs real trading is that trades execute much quicker in paper trading.
Paper trading is not only for the newbie trader. I still use my paper trading account to try new strategies, indexes or option types that I haven’t traded before. Paper trading allows you to practice placing trades, learning how to use the software. Please keep in mind things that happen while paper trading are simulations, real trading is, well, REAL!
Option Trading Software – Trade Online!
When looking for online trading software, lets first differentiate between free software provided by most brokerage firms when you open up and account and the for a fee software that plays the role of analysis, picking and recommending stocks or options to trade. While the lines between these two types of software seem to be merging as brokerage firms provide more and more analytics for free, be sure to do your homework before paying for a service you may be able to get for free.
I personally stick to the free software provided by my brokerage firm. That works for me and my strategy. Most online trading software programs available today have a wealth of analysis and charting features and provide all that the typical professional trader needs. Learn what your software has to offer and use it. Most of the companies providing software also provide excellent user guides, online training and support. And of course the best part of all of this is it’s free. One downside to the free software, it won’t tell you what or how to trade, identify hot stocks or provide you with a strategy. You may find that you utilize both the free and for a fee software.
Option Trading Analytics
Thanks to the internet there is almost more stock market analysis information available than there are stocks to analyze. Most brokerage firms provide online trading software and with the software comes charts and analytics. There is a plethora of books written on the subject, please see my resource list for some of my favorites. I am a strong believer in keeping things simple, and since I only trade index options, and stick to the same 2 – 4, I don’t have a need for complex analytics. If you are analytical by nature or have the desire to explore, google stock option analysis – you’ll find more information than you could ever want. If you’re like me and want a simple yet effective indicator for where the market is headed, check out the Relative Strength Index (RSI). The RSI measures the strength of any trading vehicle by monitoring changes in its closing prices and is included in most software packages. It is a leading indicator, not a laggard. The RSI ranges between 0 and 100. When the RSI reaches a peak and turns up or down, it indicates a top or bottom. Horizontal reference lines cut across the highest peaks and the lowest valleys. They usually are drawn at 30 and 70. Horizontal reference lines are sometimes effected by bull or bear markets. In a bull market, often the lines are drawn at 40 and 80, in a bear market, between 20 and 60. The RSI uses closing prices because they reflect the most important consensus of price for the day primarily because the settlement of traders’ accounts depend on it. Most traders look to the closing price as opposed to the price at any other time during the trading day.
The RSI is an indicator, it is not a predictor of market performance. I use the RSI as just another tool in my arsenal. It helps me make trading decisions, but it is not the only tool I use.
I also look at volume and open interest. There are three ways to measure volume, the actual number of shares or contracts traded, the number of trades, or the tick volume which is the number of price changes during a selected time frame. Some interesting things about volume.
- A trend that moves on steady volume is likely to continue
- Falling volume shows the supply of losers is drying up and a trend is ready to reverse
- A breakout on low volume shows little commitment to a new trend and indicates prices are likely to return to their trading range.
Open interest is the number of contracts help by buyers or owned by short sellers in a given market on a given day. It reflects the number of existing contracts. Open interest rises or falls depending on whether new traders enter the market or existing traders exit the market.
Option Trading Resource List
This is a list of some of the best resource books I’ve found to learn about options trading and strategies. If you have some good resources you’d like to share, please comment below and I”ll add them to my list. Thanks!
Resource List:
Understanding Options by Michael Sincere
Options Made Easy by Guy Cohen
The Bible of Options Strategies by Guy Cohen
The Rookies Guide to Options by Mark Wolfinger
Option Spread Strategies by Anthony Saliba
Trading for a Living by Alexander Elder
The Swing Traders Bible: Strategies to Profit from Market Volatility by Mathew McCall
Why Index Options?
Today was a good day in the market. It’s expiration week and my put positions are looking a lot safer than they were. 11 days ago my NDX and SPX puts were under water – yikes. I shared with my trading buddies that I felt like I needed to be revived -grab the paddles – CLEAR!! – a couple of times. But I also knew we still had time in front of us. Still I don’t know where we will end up this trading session, but I do know a couple of things.
