There are many types of traders, and no single trade method or strategy will work for everyone. The vast range of objectives, styles, experience levels, and capital levels makes this outcome virtually impossible. In order to maintain profitability and consistency as a trader you must:
- Identify which underlying(s) are suitable for your specific situation
- Identify and correctly apply the appropriate trade strategy
- Manage the position effectively
This article is intended to be a guide to strategy selection to those who may be new to trading. At the same time, some experienced traders may be looking for a new strategy because their existing “trade of choice” doesn't work in current market conditions, or there have been changes to their personal lifestyle that affect how they are able to manage a position. The options market is unique because it offers a wide variety of opportunities to earn income. The alternatives range from single long call and put positions to butterflies, condors, straddles, iron condors, and everything else in between.
Along with this diversity, of course, comes risk – which can be substantial, depending on the type of trade selected. It is essential for those new to trading to become intimately familiar with any strategy being considered, and understand all of the risks involved in addition to the rewards. Each individual must also make an assessment of their personal comfort level with any strategy, as well as the emotional effects that money-related activities such as trading will have on their stress level.
How do you find a favorite trade or underlying?
One of the first decisions you will need to address if you are looking for a trading strategy is what vehicle you will use. Tax considerations come into the picture with this decision. Certain vehicles, such as the cash-settled indices and futures, are eligible for preferential tax treatments. Tax laws change constantly and I do not want to misinform anyone on the specifics of tax advantages of trading the indices versus individual stocks. It is recommended that you consult with your tax/financial advisor on any specific tax advantages of an underlying you are considering for your own trade plan. Do your research. Some decisions on which underlying to trade may also be different depending on whether you are trading in an IRA account, or cash account.
Now you've selected a vehicle of choice, what is next?
Your personality and lifestyle must be considered when selecting a trade Do you want a mellow trade requiring very little attention/management, or does your personality lend itself to directional plays? Does your work schedule allow you time to monitor and adjust your positions during the trading day? Weeklies may be appealing to you, although weeklies require special skills to be managed properly. There's little to no comparison to how options perform six weeks from expiration and 7 days to prior to expiration. Perhaps instead of weeklies, a no-touch trade such as an Iron Condor on a cash-settled index might be a trade to explore. Depending on the particulars of this trade, you may be able to manage it completely with contingent orders. From a practical standpoint, many traders are suited to longer-term strategies as they require less attention and can be easier to manage for someone who has a full-time commitment to work or family.
One of the primary goals of every trader is to generate consistent profits and manage risk at an acceptable level. A complete and deliberate approach to strategy selection is necessary to achieve this objective. A person who is not completely knowledgeable about the advantages and disadvantages of any trading strategy being considered is likely to make uninformed and, therefore costly, decisions. There are many resources available for options education on the wide variety of strategies to choose from. Here at the Capital Discussions website, you can peruse the many resources available, including private mentoring. Do your homework; be sure you obtain the education necessary to select the right strategy for you.
If a specific strategy is not, for one reason or another, suitable for your portfolio, it should not be used, no matter how appealing it may seem. Knowing how to distinguish realistic opportunities and recognize the difference between speculation and gambling is one of the essential qualities of a disciplined, successful trader.
As was stated at the beginning of the article, there is no “perfect” position to suit every trader. Successful traders learn to maximize income potential and hedge risk in as many different ways as possible. Of course, there is no way to completely eliminate risk when trading, and educated, well-informed trader can better choose the trading strategy that suits their individual trading personality.
I hope this article has provided some guidance on how to approach selecting an options trading strategy.