Last updated on December 19th, 2016
I got an email from one of our Options Mastery students this week asking some really great questions. I’m sure these are questions that many traders have when starting out with options so I decided to answer them in this blog post.
Maybe these are the types of questions you would ask:
- How do YOU determine when to buy a call or put versus using a spread or collar or butterfly or iron condor?
- What are the criteria you are looking for to make the decision?”
I have mentioned numerous times over the past few weeks that I love the flexibility that options offer because……..
We aren’t limited to buying and selling calls and puts.
We can actually trade different options strategies that will allow us to adjust how aggressive we want to be.
To take it a step further we can also use different strategies to adjust whether we want to be bullish, bearish, or market neutral. You can’t say this about any other market out there.
If you are trading futures, Forex, or stocks you are basically limited to buying or selling individual contracts, lots, or shares. This is fine if you want to put on a directional bet but we all know that the market doesn’t always trend.
In fact, more often than not we are stuck in a sideways range.
Trading options allows us to profit from these sideways moves instead of getting whipped back and forth with false breakouts.
While the flexibility that options offer is great, I understand that it can be intimidating when starting out to know which strategy is best to use at the given time.
Over the last 13 years I have taken thousands of trades and have tracked each one. As a result, I have come up with a methodology that fits my trading style and could also help you out if you are looking for an edge in the markets.
Let’s walk through what my normal process looks like when setting up a trade.
My Options Trading Edge
Steps for Identifying Options Trades
1. Have a small universe of stocks/ETF’s that you look at on a regular basis.
I write and talk about this all the time in our training materials. I don’t want to look at hundreds of names on a daily or weekly basis because in many cases you are left trading names that you aren’t familiar with.
I would rather focus on a small list of names that I get to know over time. This way I can easily determine whether I am bullish, bearish, or neutral without spending a ton of time each day staring at the charts.
My watch list can change once a month. Currently my list is 20+ names.
Those 20+ names come from my universe of 50 stocks and ETF’s that I track on a monthly basis. In other words, when I created my watch list of 20+ names for the month, those names came from my universe of 50 products that I have tracked and researched for an extended stretch.
How do you determine which products should be on your watch list?
Check out the blog post “How To Simplify Your Trading With A Good Watch List”
2. Look at the charts for each product on your watch list to get a feel for any key levels, directional outlook, or overbought/oversold extremes.
This step is really important in helping you determine which options strategy should be used.
Example: We just closed out of an Iron Condor on USO here this week that we opened back in early September.
We chose this trade because we looked at the USO chart and saw that we were at a bearish extreme. We were expecting either a bounce higher or a sideways consolidation.
The only way I had a feel that the Iron Condor was a good strategy to use was because I have traded USO for the last few years. This gave me a comfort level with the ETF that I wouldn’t have had if I just pulled it up off a stock scan.
Looking at the charts will help us determine how aggressive we want to be.
If we are strongly bullish or bearish then we can reflect that in both position size and the options strategy that we will use.
If we are neutral then we can also adjust position size and go to options strategies that work well in sideways moves.
3. Look at the levels of volatility to determine if it’s high or low.
We track the Implied Volatility levels for each stock/ETF on our watch list. This helps us know if those levels are high or low at the given time.
- If IV is high, then we know we have the opportunity to sell premium.
- If it’s low, then we will lean towards using strategies like long calls/puts and long vertical spreads.
My first choice is always to sell premium because those strategies give us so many ways of being profitable. However, we have also seen over the years that when we wait for IV to be high when selling premium our odds of success really improve.
4. Determine which options strategy best fits our outlook.
We started by looking at the charts of each of the products on our watch list. This helped us decide if we wanted to be bullish, bearish, or neutral. This also helped determine how aggressive we want to be (position size, option strategy selection).
Once we have an opinion on what we think the stock or ETF is going to do, then we go to our playbook to follow the guidelines that we outline for each strategy.
For example, if we are bullish on a stock and want to sell a put spread then we follow our Short Put Spread criteria outlined in the Options Mastery playbook. It’s important to have criteria to follow for each strategy to make sure you are placing trades that give you good odds of success.
4 Simple Parts Of My Options Trading Plan
The 4 steps listed above are the steps that I follow in my own trading everyday. It’s important to note that this is not a perfect science when selecting trades and adjusting position size.
There are times when I want to be conservative so I trade more spreads and use smaller position size and end up leaving profit on the table. The whole goal here is to have a method in place that you can follow everyday.
We aren’t going to be perfect on every trade but by following a method we will be sure to have trades on that we are comfortable with. If this is the case and we are using proper risk management, then this will lead to us getting the number of trades on that will give us better odds.
You won’t be backing yourself into a corner by putting on 2-3 trades and hoping for the best. By having a bigger sample set of trades then the odds will better play out in the long run.
Stay Disciplined In Your Trading
As is the case with any trading approach the key is having a system that you can stay disciplined to.
Swaying in the wind with everything you hear in the media these days or from other traders can lead to inconsistent results. Every trader is a little different, so make sure you are using a trading method that fits your style and risk tolerance.
This might take time to develop your methodology but in the end it will make all the difference in the world.
It’s so important that if you don’t have a system in place now then take a big step back and don’t put any more money to work until that system is in place. You will see the benefits right away not only in your P/L but in your confidence as a trader.
In the end, trading is all about discipline.
If you can become that disciplined trader with a detailed system in place, then you will be well on your way to success.