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Options: The Sin of Trading Options?

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  1.  Report Post# 1
    This is from "A Trader's Biggest Sin" By Jeff Clark (Stansberry's option guru).......

    "Successful option traders have an 11th commandment...Risk not thy whole wad. The concept behind this rule is simple: Don't put too much money into any one trade. But you'd be surprised how strong the temptation is to break this commandment. Just imagine you've done all the analysis and you've come up with the one option trade that looks like an absolute no-brainer to double or triple in value. Why put just $1,000, $2,000, or even $5,000 into the trade? Why not go "all in," and put your entire savings into the position?" (end quote)

    Good stuff............THIS is one reason why option newsletters are misleading. They tell you they made 352% on ABC, 189% on XYZ. What they don't talk about is the SIZE of the position AND the ratio of wins to losses.

    Given that option trading is speculating, and assuming that you are using good money management principles and risk no more than 2% on any one trade, you'd have to have an account size of $100,000 for every $2,000 you can afford to risk and lose on an option trade.

    Let's say you plunk that $2,000 down on ABC and pocket your 189%. That's $3,780 in profit. Questions you should be asking are: how many times do I have to make a trade like that in a year to get a superior return on a $100,000 account? Ten times? That sounds pretty good. So one thing you should ask is: how many times in a year can I expect to hit a 189% (or better) return? BUT......the next question is: how many losers do you have to go along with the ten winners you had over the course of the year? To separtate the men from the boys: in how many of those losing trades did you part with the entire $2,000? Stated otherwise, what is the average percentage loss for all losing trades risking $2,000? 30%? 50%? Remember, all other thing being equal, options lose value with the passage of time.

    The option gurus won't likely be able to tell you the last part. How many contracts you purchase and how much you risk on a given trade is up to you. (You can always exit the position before the whole $2,000 is gone.) However, they should be able to tell you their overall win/loss percentage. If they can't or won't, I'd run the other way.........

    Keep these things in mind when considering option newsletters; and don't forget to deduct the cost of the newsletter from your profits......;>)

    Any good option stocks out there? This category is mighty lonely.
  2.  Report Post# 2
    Heres some more food for thought.


    "Picking the right expiration for your stock options can be critical. If you pick the wrong expiration you can be right and still lose money. Let me show you what I mean. You buy a $45 call for $2 on stock XYZ. You expect it to not take that long to move, so you buy it to expire in 2 weeks. The stock move from $45 to $46, but your option is only worth $1. How did this happen? You bought it too close to expiration. While the stock went up the option lost time value.

    So, how can you prevent this from happening? You have to buy time, lots and lots of time. During the last 30 days of an option’s life is when it depreciates the fastest. As a rule of thumb, when buying an option, you should buy 2 months more time than you think you’ll need. If you think you’ll only need a month, buy an option set to expire in 3 months. That way you have plenty of room if things take longer than you thought they would. It will also help your options not to lose time value.

    When you are a buyer you want to buy your option out as far out as you can. But when you are an option seller you want to sell as close as you can to expiration. This way you will take full advantage of time decay. Picking the right expiration is entirely dependent on what type of trade it is. One of the best things you can do to understand options is to start paper trading with them. "
  4.  Report Post# 3
    Good point. It's hard to get a feel for how option prices really move unless you track them day to day. Many investors only have to review their portfolios once a week. So another point to consider for option trader wannabe's is: do you have the time to track your option trades?
    • CommentAuthorcragga
    • CommentTimeApr 29th 2008
     Report Post# 4
    Some great comments in this thread, thanks. Have any of you seen 'Terry's Tips' service? www.terrystips.com He has a number of strategies and book called the 36% Solution, I bought it for 20 bucks. it is basically selling short term calls and puts while holding LEAPS on the Russel 2000. He seems to have a good track record. Would appreciate any comments, perhaps I should start anew thread for wider audience?
    Cheers
    • CommentAuthorfarley 5
    • CommentTimeApr 29th 2008
     Report Post# 5
    cragga - be sure to check with your broker to see how much they want in your margin account. Reg T says one thing, most brokers double or tripple that for naked calls and puts. Takes some big bucks to short options. They will also want to see what kind of experience you have shorting options. Rule 405 says the broker is on the hook if they let you do highly speculative trades.
    FYI.

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