Given that I decide to take on a trade based on volatility risk, consider the following:
(1) Read news. If anything significant jumps out (like earnings anouncement, new guidance, possible takeover, new contracts etc. or even something related to market at large, like interest rate change, political crisis, unemployment rate etc.) and I am reasonably swayed to one side of price movement, factor that in to my trade. This is ok, you have got to take a view sometimes. Just make sure that this view does not represent 100% of your trading risk. On the other hand, if you cannot reasonably be swayed to one side of price movement (whether there is significant news on the underlyer or there is absolutely none), then stick to 100% of volatility risk.
(2) Make the trade. Always embed a stop loss. I like the trailing stop or trailing stop limit (the latter is little riskier)
(3) Constantly modify your trade, relative to market news and changing volatility? how to do this?
Thursday, May 13, 2010
Options Trading has essentially 2 strategies
Abbreviations used
==============
ST = Short Term
LT = Long Term
With options trading, you are essentially trading
(1) direction in which the underlyer will move ST
and/or
(2) volatility of underlyer
Strategy (1) is very difficult to achieve as a LT goal, akin to the difficulty of beating the casino over a long period of time. Even though you might still believe you have a good chance of consistently making profitable trades based on (1), if you haven't started trading strategies based on (2), you are missing out big time and honestly you are bound to be doomed over LT!! (2) is far more achievable LT than (1). Period.
It's true what I said above is nothing new - it's been explained, researched and demonstrated to be true in academia and on the street for ages. Still, what makes people forget and concentrate on (1), at least initially? The answer is simple. (1) is easier to understand and make decisions on. Initial success might even push you into playing more. If you are a bit shrewd, you probably understand the winning streak won't last very long. Yet you push it to one more play, thinking the luck has probably not changed course yet and sure you can afford to lose this one play and still profit if you stop right afterwards. Ha! Know this feeling? And then you keep going even after that one loss, thinking oh well, what are the chances of another loss again when I have made more wins so far? I swear if I win 2 more, I will stop and go home happy. On and on! I mean come on!! I happen to be a pretty good player at roulette and I have had far more wins than losses so far in my life but I also know when to stop, either after losing the entire budget I had set aside BEFORE entering the casino (NOT after) or after I have made some profits that I'm comfortable with (not letting my greed get in the way).
As of writing this blog, I'm beginning to focus more and more on (2) while still trading (1), albeit applying more restraints on (1) than I had before. Like many traders, I find it impossible to let go of (1) entirely. I will need to act on it more judiciously but definitely play it.
Conclusion:
==========
Trade (2) consistently while trading (1) judiciously, knowing that (1) alone will likely make you a loser over LT.
==============
ST = Short Term
LT = Long Term
With options trading, you are essentially trading
(1) direction in which the underlyer will move ST
and/or
(2) volatility of underlyer
Strategy (1) is very difficult to achieve as a LT goal, akin to the difficulty of beating the casino over a long period of time. Even though you might still believe you have a good chance of consistently making profitable trades based on (1), if you haven't started trading strategies based on (2), you are missing out big time and honestly you are bound to be doomed over LT!! (2) is far more achievable LT than (1). Period.
It's true what I said above is nothing new - it's been explained, researched and demonstrated to be true in academia and on the street for ages. Still, what makes people forget and concentrate on (1), at least initially? The answer is simple. (1) is easier to understand and make decisions on. Initial success might even push you into playing more. If you are a bit shrewd, you probably understand the winning streak won't last very long. Yet you push it to one more play, thinking the luck has probably not changed course yet and sure you can afford to lose this one play and still profit if you stop right afterwards. Ha! Know this feeling? And then you keep going even after that one loss, thinking oh well, what are the chances of another loss again when I have made more wins so far? I swear if I win 2 more, I will stop and go home happy. On and on! I mean come on!! I happen to be a pretty good player at roulette and I have had far more wins than losses so far in my life but I also know when to stop, either after losing the entire budget I had set aside BEFORE entering the casino (NOT after) or after I have made some profits that I'm comfortable with (not letting my greed get in the way).
As of writing this blog, I'm beginning to focus more and more on (2) while still trading (1), albeit applying more restraints on (1) than I had before. Like many traders, I find it impossible to let go of (1) entirely. I will need to act on it more judiciously but definitely play it.
Conclusion:
==========
Trade (2) consistently while trading (1) judiciously, knowing that (1) alone will likely make you a loser over LT.
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