Transitioning over to options trading- a few questions

[goofy]

Hi everyone. I traded crypto markets since 2016 and the last year or two have been abysmal to say the least. Liquidity is gone, the scam market has collapsed and I am looking to move on to real, traditional markets. I've been experimenting for the last few months with options using RH and Tastyworks. I am used to trading on high leverage and options appear to be the best way to easily short/long an asset with good liquidity, low fees, and no significant lending rates.

A few things are still confusing me. Let's say I have a clear entry on the SPY. I get signals to short it and I have an area which I am targetting for my short. But, I don't really know "when" it's going to get there. How do I know what strike date(s) to choose? Do I just estimate roughly when I believe my target price will be hit based upon the chart timeframe I am trading, buy a put for that date with my strike price and set alerts for when my price target is near, then manually go in and evaluate whether or not to close the option? I had a few plays in which I correctly knew a stock was going in a certain direction but I either held onto it too long near the expiry date, or I had chosen an expiration date that was too early.

For example, this Monday I bought puts on MU, TWTR, and NVDA. I was unsure how to really determine an appropriate expiration date so I picked late oct/early november, figuring this was a reasonable conservative choice. How would I determine whether the risk/reward favors buying something a month or two out and taking the conservative approach, assuming I believe the stock is going down in that time period, vs buying something a week or two out as more of a gamble. That puts into play the risk that the stock does indeed go in my direction it just takes an extra week or two, and my options are worthless. Would you typically buy multiple strike dates such as a 2 week settlement, and a 2 month settlement in this situation? Somewhat of a hedge against each other?

Second, in a normal trade you would set a take profit target and your trade would auto close if it hits. But given the complexity of options and the additional factors such as time decay and expiration dates, it seems difficult to set a "take profit" in an option trade. I guess what I am asking is, how do you determine when you want to take profit given that you can't set a close on a particular price? I need to set alerts for when the price hits my target and then go in and manually close the option?
Lastly, how do I factor in earnings or other news based events into my options trades? I would prefer not to follow news or earnings as I am used to just trading charts. Is this a critical factor in being a successful option trader? Would it be wise to have no active positions immediately before and after earnings reports in order to avoid this sort of variance, or is that a time in which the best traders are making most of their money? I'd like to not do much fundamental analysis if possible.

Lastly, how does one determine a reasonable risk management system for options given how significantly the risk/reward can vary depending on strike price/dates? Would a 1% risk of your portfolio per option trade(assuming it expires worthless) be reasonable?

Any input from options traders would be greatly appreciated. Thank you.

 

[cvds16]

a conservative approach is taking options 3 months out because closer get theta working way harder against you ...
the wise thing to do would not to have options just before important news reports because implied vol can suddenly drop a lot after the event ... however that's not always possible in an ideal world

 

[marameo]

Lastly, how does one determine a reasonable risk management system for options given how significantly the risk/reward can vary depending on strike price/dates? Would a 1% risk of your portfolio per option trade(assuming it expires worthless) be reasonable?

1% assuming it expires worthless means the option has to double its value in order to have a 1% profit.

 

[maximumpossiblesuffering]

Hi everyone. I traded crypto markets since 2016 and the last year or two have been abysmal to say the least. Liquidity is gone, the scam market has collapsed and I am looking to move on to real, traditional markets. I've been experimenting for the last few months with options using RH and Tastyworks. I am used to trading on high leverage and options appear to be the best way to easily short/long an asset with good liquidity, low fees, and no significant lending rates.

A few things are still confusing me. Let's say I have a clear entry on the SPY. I get signals to short it and I have an area which I am targetting for my short. But, I don't really know "when" it's going to get there. How do I know what strike date(s) to choose? Do I just estimate roughly when I believe my target price will be hit based upon the chart timeframe I am trading, buy a put for that date with my strike price and set alerts for when my price target is near, then manually go in and evaluate whether or not to close the option? I had a few plays in which I correctly knew a stock was going in a certain direction but I either held onto it too long near the expiry date, or I had chosen an expiration date that was too early.

For example, this Monday I bought puts on MU, TWTR, and NVDA. I was unsure how to really determine an appropriate expiration date so I picked late oct/early november, figuring this was a reasonable conservative choice. How would I determine whether the risk/reward favors buying something a month or two out and taking the conservative approach, assuming I believe the stock is going down in that time period, vs buying something a week or two out as more of a gamble. That puts into play the risk that the stock does indeed go in my direction it just takes an extra week or two, and my options are worthless. Would you typically buy multiple strike dates such as a 2 week settlement, and a 2 month settlement in this situation? Somewhat of a hedge against each other?

Second, in a normal trade you would set a take profit target and your trade would auto close if it hits. But given the complexity of options and the additional factors such as time decay and expiration dates, it seems difficult to set a "take profit" in an option trade. I guess what I am asking is, how do you determine when you want to take profit given that you can't set a close on a particular price? I need to set alerts for when the price hits my target and then go in and manually close the option?
Lastly, how do I factor in earnings or other news based events into my options trades? I would prefer not to follow news or earnings as I am used to just trading charts. Is this a critical factor in being a successful option trader? Would it be wise to have no active positions immediately before and after earnings reports in order to avoid this sort of variance, or is that a time in which the best traders are making most of their money? I'd like to not do much fundamental analysis if possible.

Lastly, how does one determine a reasonable risk management system for options given how significantly the risk/reward can vary depending on strike price/dates? Would a 1% risk of your portfolio per option trade(assuming it expires worthless) be reasonable?

Any input from options traders would be greatly appreciated. Thank you.

All traders have different perspectives and they should do whatever seems to make sense to them in their specific situation.

That said, and that part of my trading strategy that considers long options, especially puts, assumes price declines will happen over a shorter period of time versus price rises. In addition, I am looking for a very tight window from a timing standpoint. I will not tolerate a stock taking out a previous day’s high against my long put position or a threshold amount above the opening any given day while my long put trade is on. Therefore, I will look to go long a .40 delta long put and use a target equivalent of 1 standard deviation, or as implied with a .16 delta, or a little higher to account for IV overstatement, put at order entry. My stop, as stated above, will be based on the previous daily high or current day’s opening plus a threshold amount, whichever is lower. The last thing I need to be paying theta on a underlying that is acting against my outlook. When a trade goes for me, the greater gamma will help me multiply my money. When a trade goes against me, the greater gamma will help reduce the dollar amount of a losing trade. Obviously IV changes need to be considered as well, but over time should roughly balance out.

I believe to profit from extended price moves during major earnings surprises requires exceptional company, industry, and sector understanding in order to beat volatility crush.

 

[ironchef]

My humble suggestion for you is to study a couple of books on the fundamentals of options, including how the market, the professionals priced options before you start trading. The books I used as references are:

1. Lawrence McMillan, Options as a Strategic Investment

2. John C Hull, Options, Futures and Other Derivatives

3. Collin Bennett, Trading Volatility Correlation, Term Structure and Skew

If you are really good at Mathematics,

4. Tomas Bjork, Arbitrage Theory in Continuous Time

#4 is very mathematical and I had a hard time wading through the equations but there are some very interesting conclusions from the mathematics if you read carefully.

If you are like me a mom and pop amateur retail, we are essentially trading against the market makers and professionals and they won't hand over their money without a fight. If we make money, it is more likely because of luck, not skill.

Best wishes.

 

[gaussian]

A few things are still confusing me. Let's say I have a clear entry on the SPY. I get signals to short it and I have an area which I am targetting for my short. But, I don't really know "when" it's going to get there. How do I know what strike date(s) to choose?

This is a traditional place for shorts. When IV is high and you have an idea of "where it won't go" you can short an option (or a spread) and essentially place a bet saying "the thing I am betting on will not be worth more than X".

I had a few plays in which I correctly knew a stock was going in a certain direction but I either held onto it too long near the expiry date, or I had chosen an expiration date that was too early.

When you are long options you are not only playing against the clock you are also hoping volatility will rise. It's a losers game for the most part. Long options are good plays when you expect an increase in vega around some binary event but other than that I can't see a use for them in speculating.

Second, in a normal trade you would set a take profit target and your trade would auto close if it hits.

For single unit orders you can run a TP/SL strategy. For anything more complicated you really can't accurately determine a stop or take profit in an automated sense. There are too many variables.

Lastly, how do I factor in earnings or other news based events into my options trades?

A rule of thumb I follow is around 4 weeks out from earnings volatility of the ATM straddle starts to rise. It peaks the day before earnings, and typically plummets 1 to 2 days after.

If you are long 4 weeks out, you will want to sell before earnings. If you are short, you'd carry through earnings and sell the minute volatility crushes.

Lastly, how does one determine a reasonable risk management system for options given how significantly the risk/reward can vary depending on strike price/dates? Would a 1% risk of your portfolio per option trade(assuming it expires worthless) be reasonable?

Base everything on your maximum possible loss. Your maximum possible loss on all options in your portfolio should not be more than N% of your account.

 

[ironchef]

Lastly, how do I factor in earnings or other news based events into my options trades? I would prefer not to follow news or earnings as I am used to just trading charts. Is this a critical factor in being a successful option trader? Would it be wise to have no active positions immediately before and after earnings reports in order to avoid this sort of variance, or is that a time in which the best traders are making most of their money? I'd like to not do much fundamental analysis if possible.

Typical option pricing priced in the event (e.g. earning) based on market's expectations. To make money, you have to be more correct than the market sentiment at the time of your entry. Folks using BSM usually have factored in IV = IV(base) + IV(event). IV(event) has a time element and is time dependent.