Watching a popular investor anonymously chastise a few traders who had posted bankruptcy-inducing net option losses brought a few points to mind.
(The common denominator of these losses was little to no evidence of [even flawed] logical analysis or due diligence, by the way.)
These are some aspects of my own trading strategy that I think are important to make note of.
This is not personal financial advice of any kind and is for educational purposes only. You alone are responsible for all actions you take as well as any subsequent gain or loss incurred. Options trading is inherently higher-risk and may not be suitable for all people. Consult your own licensed professional.
1. I trade with only what I can afford to lose. (And my account is funded by what I can afford to lose.)
Every once in a while, when I feel like it, I’ll let a sliver of YOLO slip through. But I never have and (probably) never will throw my whole account into any one or two trades. In some of the videos I’ve posted, I mention that a particular trade involves about 20 percent of my account. That’s a pretty large amount of an account to be tied up in a single trade. But what I haven’t mentioned is that I trade “recreationally” for lack of a better word and that the entire account—not just the one trade under discussion—is funded with what I can afford to lose. It is also more or less mathematically worked out that I can get 1 in 4 trades right and still be alright in the long run. Do I aim for 1-in-4 profitable trades? No. I aim for 4-in-4 and approach all four as best as I can, but the fact is with what system I feel I stick to, just one in four trades could be profitable and the account would never zero out.
Faux Example:
| Trade No. 1 | 100% loss of $85 |
| Trade No. 2 | 100% loss of $125 |
| Trade No. 3 | 100% loss of $168 |
| Trade No. 4 | 500% gain on $126 (= $630) |
| Net Result: | + $252 gain. |
Note #1: I aim for 4-in-4 profitable trades; nevertheless if only 1-in-4 is profitable, the account survives.
Note #2: The 100% losses above can be limited [sold earlier to cut losses], providing the option doesn’t gap down badly after hours or premarket.]
For a day trader or a professional trader to do this—enter 20% of his account into a trade—would be insane.
Andrew Aziz, for instance, in his How To Day Trade for a Living (© 2018), warns day traders: “Do not take a trade if more than 2% of your account will be put in jeopardy. It very simply is not worth the risk.” (p. 52) Note that he also says, “I don’t trade Options.” (p. 31)
(Most day traders I know of move thousands of dollars into and out of a stock, hoping to capitalize on minute (tiny) increases in the price of the stock. Multiplied out over the several thousand dollars they moved into and out of that trade, it could be profitable. But a few ticks down and it could also be a catastrophe. Thus the 2% rule.)
While I do due diligence until I’m satisfied that the trade is likely to be profitable according to the data that I’ve been able to gather, despite how confident I may be, I still move no more than 20% of the account into a trade, usually much less. This usually equates to a few hundred dollars. If I lose it all, I’ll live. I’m more or less on a continual “account challenge,” trying to turn a small amount of money (usually $700) into $4,000 – $5,000. I’ve “blown it up” once, and have cashed out at $4 – 4.5K several times.
(Note that I’ve blown up an account of $700, after losing the ability to day-trade for 90 days, which was an infrequently used but important fall-back in my strategy. Stupidly, I lost that day trade ability while trying to ‘get the perfect shot for the gram’ if you know what I mean.)
2. I don’t buy options without an exact catalyst in mind.
At its most basic level, a call options contract is a bet that the underlying stock is going to increase enough for you to profit–during the time that you are still in possession of that contract!
For all the complexity, terminology, and possible usages surrounding options, if these three simple stars align, your trade should be profitable:
| 1 | Stock go zoom. |
| 2 | Stock go enough zoom—relative to the strike price of the call you bought. |
| 3 | Stock go enough zoom before the strike date (end) of the call you bought. |
Let’s look at this another way:
| If: | Buying a call option assumes you believe the stock price will go up enough before your call expires. |
| Then: | What catalyst(s) exactly are you counting on to cause that price increase to occur within the option’s lifespan? |
| Else: | You are gambling and calling it options trading. |
The more we can correctly extrapolate the outcome of events related to a stock, the better options traders we are.
3. I pick stocks backward.
I get some ideas of what stocks to consider trading options against from places like StockTwits, Twitter, and YouTube. But I never duplicate another trader’s trades and usually don’t even follow their “three top trade ideas for this week.” But, it does help to keep up to date with them and what they mention that they are watching.
Instead of looking at the chart side of a stock, I most often tend to do it the other way: If I come across news on a company, I try and better understand what effect that news is likely to have on the stock.
Some examples of this:
- Instagram ($FB) announces Reels, while a TikTok ban is under discussion. Hello Facebook!
- Microsoft announces it is permanently closing all retail stores—they were a net loss. Money.
- Disney+
- Stay-at-Home orders: What companies benefit?
- Earnings reports
4. I trade options for fun, I’m not obsessed with the money.
Compared to options, the ordinary Buy & Hold of stocks is a long, slow, and very boring play in my opinion. Options, as I typically trade them, are faster-paced and exciting. (I trade weekly’s, with strike dates of one or two weeks out.) There’s something validating about postulating the future trend of an asset, based on whatever well-reasoned or grossly-flawed logic I used to “predict” that outcome. Even if you have absolutely no idea of what is meant by technical analysis or fundamental analysis, as long as you apply some sort of logic to your trades, your trading should improve over time. The first options I bought—and this was after reading most of two options books and watching eight hours of video—were utterly embarrassing, so far out-of-the-money it hurts type options. The first five or seven trades I did were all 100% losses.
But the important things to me were:
- Small positions; trading only what I could afford to lose.
- Basing even these trades on some sort of logic—even if it was horribly flawed.
If you do any sort of due diligence, over time, you should get better and better at options trading. Even if you begin with absolutely no idea of what you are doing.
5. If I miss a great run up, I’ll sit on the sidelines for the next.
On Monday, $AMD shot up 11% on the day. It wasn’t a gap up from premarket, but a nice, healthy increase throughout the trading day. They’d received a contract (or word on a future contract) with Meta (Facebook’s new parent company). Though I love AMD for a swing trade and have never been fooked by it, I had no position in AMD. Was it painful? Yes, very. But did I jump in? No. I’m up at 6 am and looking loosely at stocks. AMD looked fantastic, but what I was missing is I hadn’t been doing any sort of light due diligence on it for weeks. I had no feel for it and thus would have had no confidence in the trade.
6. I spend a lot of time learning about options in general.
I have yet to take a course in options. Because I know how leveraged options actually are (or can be), the thought of a paid course confuses me and too many of them are scams. (Teacher, if options are so profitable—and I know they are—why teach when you could be trading?) Despite this though, I spent plenty of time watching videos and reading books on options. Even as a non-professional and part-time trader, I think this is incredibly important.
7. I keep a watch list and do constant lite due diligence.
If I’m going to be trading, I’ll keep some attention on the market and as many significant developments in it that I can. Same for companies that I’m likely to be trading: I put them on a watch list and just remain at least lightly abreast of what they’re doing, any key news and events, earnings reports, etc. Then, when I see something that indicates there might be a good trade there, I’ll go the next level deeper in research.
8. I’m not always in a trade.
Aside from taking breaks from trading for a few days or weeks every so often, I’m also not constantly in trades. I spend an hour or two daily keeping up with the market and making mental notes of what trades might be worth getting into. But I’m definitely not always in a trade. If I don’t see something that looks good, I’ll wait.
9. I decide what I want out of a trade before entering it.
The first time I saw one of my options increase by $80 in a day (5.63%), I took a screenshot and sent it to my significant other. It was exciting. Now it’s embarrassing. Well not really, but it’s certainly nothing compared to what options have become for me. The last trade I did netted about a 571% return. Some return 1,000%. I’m mid a Bank of America ($BAC) trade right now that could return 0% — after averaging down twice, I may let the option expire worthless. Why? Why not pull it now? Because I went into the trade believing a catalyst was going to occur before the strike date (November 12) and I’m still fairly confident that is going to occur. But if it doesn’t? I’ll have lost $269.00. And that’s alright.
10. I trade options only on a loosely defined set of stocks that let me to buy ~4-10 contracts.
Some stocks trade too expensively to make call options on them a part of my strategy.
Tesla, down 12% today, is one of them. At $1,024, it’s too expensive for (my style of) call option contracts. The cheapest $TSLA call that might reasonably be worth trading is $2,610.00 [TSLA $1,045 Call 11/12]. I’m not skilled enough or stupid enough to confidently put down more than $1,000 for a single call option.
For the style of trading that I do, that’s unworkable. I prefer a stock that I can take out multiple call options on—somewhere between 4 and 10 or 12. That allows me to respond to various changes that might happen while I’m holding that call.
AMD, Intel, Uber, PayPal, Palantir, and Microsoft are examples of stocks that I’ve previously traded with this strategy.
Example of Most Recent Options Swing Trade ($INTC; Intel)
| Buy | Nov 4, 2021, 6:30 am | Buy 5 calls @ $0.18 = – $90 |
| Buy | Nov 4, 2021, 6:34 am | Buy 1 call @ $0.12 = – $12 |
| Buy | Nov 4, 2021, 6:46 am | Buy 6 calls @ $0.11 = – $66 |
| Sell | Nov 5, 2021, 7:03 am | Sell 2 calls @ $0.75 = + $150 |
| Sell | Nov 5, 2021, 8:00 am | Sell 8 calls @ $1.00 = + $800 |
| Sell | Nov 5, 2021, 10:47 am | Sell 2 calls @ $28.00 = + $56 |
| = | Net Risk: $168 | Net Return: $1,005 |
Notes on this trade:
- I averaged down twice because I believed my catalyst was accurate. It could have proven to be inaccurate, in which case I lose all $168 (unless I opted to close the contracts to cut losses before their strike date.)
- I sold three times: First, to remove nearly all risk from the trade (2 of 12). Second, for the bulk of profits near what I thought was peak. (8 of 12) Third, to close the two remaining calls I had left to catch any additional upside—which proved futile in this case and cost me $144.
Good luck. Please remember, there are plenty of traders far more experienced than I and that none of this is personal financial advice of any kind. Options are very high risk and are not suitable for all investors. You could lose your entire investment. As tempting as it might be, please do not YOLO your life savings in hopes of winning the options lottery.
Always, always, always, ask yourself — What happens if I’m wrong? Can I live with having lost this entire investment?
