Need help on new strategy

Adamoptions · Aug 31, 2003

When the market finally breaks out of this trading range I want to be ready because I think the direction it chooses will be strong for a while. I'm fairly new with options. Most of my knowledge is bookish so I would like advice from experience traders:

If market goes bullish, my plan is:

1. Use Investors Business Daily list of Best 100 Stocks based on fundamentals.

2. Narrow the list down to stocks related to indexes that are trending.

3. Sell credit spreads on the trending indexes that have IV below it's 85th percentile. Sell naked on trending indexes with an IV above the 85th percentile. By sticking to the indexes, I lower my risk of large gaps. It also gives me some place to roll if the price fails it's trend, reverses and hits my strike. I keep these short positions relatively small to keep my risk small. The objective is to help pay for the losses incurred on my long positions.

4. Continue to monitor for a good entry point on the stocks connected with the indexes. Enter a position by buying the underlying stock so I can keep a tight stop loss and minimize the effect of the bid/ask spread. If the stock shows a small profit, sell the stock and build the same delta position with slightly deep-in-the-money, near expiration options.

By entering the position with the stock I minimize my loss if I hit my stop. But if I get a small profit, I switch to options and the small profit will cover some or all of the option premium and the bid/ask spread. Play like a position trade from here.

That's the basically the idea. The focus is to keep my losses as small as possible. Has anyone done this? What are your opinions of it? Remember, I'm a newbie so please keep sarcasm to a minimum.

Thanks

lindq · Aug 31, 2003

Quote from Adamoptions:

Remember, I'm a newbie so please keep sarcasm to a minimum.
Thanks

New to trading, or new to options? What's your trading experience?

timytime · Aug 31, 2003

I have many years of trading options under my belt. The surest way to minimize your profits is to use spreads as trading vehicles. One trades options for the leverage that it provides. Spreads:

1. Ax leverage

2. Are very costly to operate

3. Give trader false sense of comfort

Forget about all of the very complicated strategies! Decide if you want to trade the indexes or straight stock options. Indexes have much more liquidity. Make your bet long or short and use stops. Remember, 90% of all option traders lose money so you are bucking some very big odds. I have had great months and horrible months and I quit trading them because I could not consistently make money like I can trading stocks.
Good luck!

GATrader · Aug 31, 2003

you might want to do it backwards wherein you are buying options on the stocks and buying/selling the indexes outright as a hedge. Indexes by their nature are less prone to gaps not like indiv stocks so it makes sense to use the options on the stock side.

ktm · Sep 1, 2003

Sounds like you have a pretty well thought out plan. I would suggest putting it into play and see what happens.

There are a lot of good options traders here. Some might tell you it won't work or make some suggestions to make it better. Some of these guys make a lot of money doing things I NEVER thought would work.

The key (IMHO) is finding something that will work for you that fits your personality and risk tolerance. Once you get real money on the table, you will be able to watch your positions behave and then have to deal with unexpected outcomes. This will force you to make adjustments and improve the strategy or try something else. It sounds like you've done enough homework to get your feet wet. Go for it.

Hello_Dollars · Sep 1, 2003

Adam,

I agree wholeheartedly with ktm. If you've done enough research such that you're confident in the theoretical viability of the strategy, then I too suggest you try it out in the real world. ktm's point about the compability of a trading strategy and one's own idiosynchratic trading personality is critical and, unfortunately, doesn't get enough attention. Personally, I dabbled in a number of options strategies before settling on just a few a couple years ago that, in addition to having a positive expectancy, best fit my particular trading personality. For example, since I'm much better at taking losses than I am at taking profits, it's easier for me to determine where a market's likely not to go than where it will, I'm a better trader when I'm not overly invested in a directional movement one way or the other, and I'd rather be Wade Boogs than Dave Kingman, I focus mostly on delta neutral, theta positive trades.

So the only way to know for sure whether you're onto something is by putting some real money to work and manage the positions in the real world. Good luck.

Regards,

HD

murray t turtle · Sep 1, 2003

Quote from timytime:

I have many years of trading options under my belt. The surest way to minimize your profits is to use spreads as trading vehicles. One trades options for the leverage that it provides. Spreads:

1. Ax leverage

2. Are very costly to operate

3. Give trader false sense of comfort

Forget about all of the very complicated strategies! Decide if you want to trade the indexes or straight stock options. Indexes have much more liquidity. Make your bet long or short and use stops. Remember, 90% of all option traders lose money so you are bucking some very big odds. I have had great months and horrible months and I quit trading them because I could not consistently make money like I can trading stocks.------------
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Tinytime;

Excellant points;
an occasional simple spread ,like a straddle with a directional bias is costly and can be worthwhile occasionaly anyway.

Adamoption;
Notice i underlined''consistantly make money like I can trading stocks''

Option trends are much more complex, inconsistant, even a long call in a bull market.

There are lots of ''horrible''[ or nonexistant profit months ]in put moves compared to any downtrending index or downtrend ing underlying stock months.

Learned to trade stocks first[1st] like William O'neill wrote in IBD.

murray t turtle · Sep 1, 2003

Quote from Adamoptions:

When the market finally breaks out of this trading range I want to be ready because I think the direction it chooses will be strong for a while. I'm fairly new with options. Most of my knowledge is bookish so I would like advice from experience traders:

If market goes bullish, my plan is:

1. Use Investors Business Daily list of Best 100 Stocks based on fundamentals.

2. Narrow the list down to stocks related to indexes that are trending.

3. Sell credit spreads on the trending indexes that have IV below it's 85th percentile. Sell naked on trending indexes with an IV above the 85th percentile. By sticking to the indexes, I lower my risk of large gaps. It also gives me some place to roll if the price fails it's trend, reverses and hits my strike. I keep these short positions relatively small to keep my risk small. The objective is to help pay for the losses incurred on my long positions.

4. Continue to monitor for a good entry point on the stocks connected with the indexes. Enter a position by buying the underlying stock so I can keep a tight stop loss and minimize the effect of the bid/ask spread. If the stock shows a small profit, sell the stock and build the same delta position with slightly deep-in-the-money, near expiration options.

By entering the position with the stock I minimize my loss if I hit my stop. But if I get a small profit, I switch to options and the small profit will cover some or all of the option premium and the bid/ask spread. Play like a position trade from here.

That's the basically the idea. The focus is to keep my losses as small as possible. Has anyone done this? What are your opinions of it? Remember, I'm a newbie so please keep sarcasm to a minimum.

Thanks

=====
[1] I am glad i did NOT usually trade as large as 100 shares[or 1 contract ] of SPY,DIA when beginning to swingtrade;
William O'Neill wanted traders to learn stocks before options.

[2]Stock indexe[s ] or 1[one] index option contract should be less risky than the best stock.

[3]Do NOT know of any way to have ''small'' option stop losses profitabley,not compared to NYSE stop losses;
notice TinyTIME is not spending TinyTime in options anymore.

[3.3]Books are real helpful;
no substitute for study [or occasional trade of]of many,many,many closing prices on options & stocks.

[3.33]''The plans of the diligent tend only to advantage''-Solomon,trader king.

Adamoptions · Sep 2, 2003

Thank you all for the fine responses.

My experience in serious trading is 6 months old. I've focused mostly on straddles following McMillian's method and I've had moderate success but I've noticed a few things. First, every straddle that I have played has broken to the side I initially predicted. I don't take this as an indication that I can read the direction of stocks. I see this as a basic flaw in straddles. The price has to swing so far in one direction or another that the price ALWAYS seems to go with the direction of the market trend.

True, in a tight range like what we are experiencing now it's tougher to read that direction and perhaps it's better not to go long at all until a direction is established, but once a trend is in place a well managed strategy of straight plays will probably outperform spreads. Yes, I agree with tinytim on his feelings of spreads.

In straddles or backspreads, when you consider the amount of money you lose until you actually touch a breakeven point plus the amount of time you have to tie up capital (I average 70 days in a straddle), you get the feeling that a straight directional play with tight stops will be more efficient. I don't feel you can use tight stops on options. That's why I think it's better to enter the trade actually buying the underlying and, if a profit shows up, switch to the option and hopefully leverage your gain after the stock has demonstrated some strength. Based on IV, I would decide buying a deep-in-the-money option vs. a vertical spread.

As far as volatility trading goes, implied volatility is probably more predictable then price direction, but I don't see volatility trades being more profitable then price direction. As retail traders, the regular adjustments to keep your trade delta neutral is just too costly. If you don't make regular adjustments the positive gamma will have you playing price very quickly. Yes, you didn't need to pick a direction initially, but you will still have to figure out when to exit the trade based on price. I'm finding that the "buying the privilege" of not having to pick the initial direction is just too expensive, particularly since the direction usually goes with the prevailing trend.

Further, though I very often pick the right direction of IV, often IV doesn't move far enough or fast enough for me to get any real advantage from it. Often the best volatility trades lack liquidity so whatever theoretical edge I start with is usually nullified buy the wider bid/ask spread. Basically, I don't see enough return here to justify the risk. The gains are there, but too small. One big mistake will wipe out most of the gains.

My limited experience has brought me to a strategy that tries to capitalize on the advantages the underlying and the option. I see the underlying with more liquidity, making it easier to keep losses tight and allowing effective use of stop loss orders. The advantage of the option comes from any theoretical edge you can get from IV and leverage. I hope that effectively combining the two at the right times will produce smaller losses and greater gains over spreads. We'll see.

lindq · Sep 2, 2003

Quote from Adamoptions:

Thank you all for the fine responses.

My experience in serious trading is 6 months old.

Adamoptions, there isn't an options strategy in existance that will profit you consistently unless you are first successful in predicting the movement of the underlying.

For that reason, you should not touch options until you are a consistently profitable stock trader. Master that skill first, as everything rides on that.

Understand that in every way, the odds in trading options are stacked against you. If you haven't first completely mastered the skills of trading, you have another strike against your success.

I speak from the experience of trading stocks and options for many years.

Specifcally, with regard to your original post, it has already been pointed out that credit spreads are hardly worth the effort. I second that. Regarding shorts on indexes, I have two comments. Naked options of ANY kind are a bomb waiting to go off in your account. Trade stocks for 5 years before selling naked, if ever. Naked options on indexes seldom if ever pay enough premium to make the risk worthwhile. The couple dollars that you collect will look pretty damn silly when you are faced with taking the stock, or rolling out hoping for a recovery.

On paper, all of these strategies look interesting and challenging. In reality - especially in the hands of a novice - they suck.