Best Way to Learn Options Trading?

[OldShooter]

... I have a different take on purchasing options, I believe in identifying market turns and only reacting to what a market turn indicates. ...

I like it! Please let us know each time one of these market turns is about to happen.

 

[NW-Bound]

The call options I wrote are all in the dirt today. It is highly unlikely that they are going to be worth anything on Aug 16, when they expire.

I still lost money with the market going down so badly, but with these options, I lost about $10K less this month than if I did not sell these options.

I don't think I made money off professional institutional investors. I most likely make money off other retail investors who try to get rich quick.


PS. By the way, options on individual stocks and even some ETFs can be quite thinly traded. At a particular strike price and expiration, there are often just a couple of contracts traded each day. Often, there are none traded in a day.

 

[GalaxyBoy]

The only time I did options was in 1986 when I made a few thousand bucks on Intel. A better move would have been to exercise the call and hold the stock for a decade or two.

 

[jldavid47]

PS. By the way, options on individual stocks and even some ETFs can be quite thinly traded. At a particular strike price and expiration, there are often just a couple of contracts traded each day. Often, there are none traded in a day.

Individual options that are inactive are NOT illiquid necessarily. You can always buy any individual option if you are willing to pay the ask and can always sell an individual option if you are willing to accept the bid. That's what market makers are for. Looking at the volume in an individual option tells you nothing. If you want to judge the real liquidity of an option, look at the volume of the entire chain and/or the bid/ask spread. Options with narrow bid/ask spreads are liquid regardless of the volume.

 

[NW-Bound]

Yes, I have made quite a few trades with a computer on the other end.

 

[jldavid47]

The call options I wrote are all in the dirt today. It is highly unlikely that they are going to be worth anything on Aug 16, when they expire.

When your covered calls are "in the dirt" the thing to do is buy them back. What's the point of holding on for the last penny or two?

I don't think I made money off professional institutional investors. I most likely make money off other retail investors who try to get rich quick.

No, most likely is when you wrote your options the market maker on the other side took your trade then immediately laid off his risk. That's how they do business. There may or may not have been a matching retail order on the other side.

 

[NW-Bound]

Yes.

What I meant is that although I made money, it did not necessarily come out of the market maker's pocket. Some other retail traders most likely get the worthless options at the end, but I am not sure.

And I usually split the bid/ask prices, and with a tilt if necessary so the computer will take a bite.

 

[misanman]

I've been selling a few covered calls each month. The stocks are usually ones that I'm considering selling anyway. The premiums vary from day to day so I check occasionally to see if what I can get from selling the covered call is worth the trouble. I would say that 85% of the time the options expire. I've let the few stocks that are called go for the most part. One time I really wanted to stay with the stock so I bought it back later.

 

[NW-Bound]

When your covered calls are "in the dirt" the thing to do is buy them back. What's the point of holding on for the last penny or two?

Well, I still pay $3.30 to trade one contract at my brokerage. And then plus a few pennies a share, that is $5 to $10 to close out an option. When I have 20 to 30 contracts out each month, that's still $100 to $200 a month that I could have in my pocket, if it does not look like the stocks have climbed enough to allow me to write another option on them.

But with the market as volatile as it has been the last year, I have seen options in the dirt become in-the-money in a matter of a week, and I get assigned and lose my good shares. Crazy stuff.

I have learned to give up the gain of the last few bucks because of that risk. No point in being greedy if I can buy back an option for 1/10 of the price I sold, unless the expiration is due soon, and I mean less than 1 week away.

 

[jldavid47]

I have learned to give up the gain of the last few bucks because of that risk. No point in being greedy if I can buy back an option for 1/10 of the price I sold, unless the expiration is due soon, and I mean less than 1 week away.

Exactly, but you even need to be watching in the last week.


Here's a rule of thumb for writing covered calls that seems to work rather well:


1) Write delta 30 calls 2-4 weeks out.
2) If the delta of those calls rises above 55 or so, roll out to a 30 delta in a farther expiration.
3) if the delta drops to 10, cover the call position and start over with step 1 when you want to write again.


A strategy like that works best if applied consistently and with discipline (like pretty much any other strategy lol)



YMMV

 

[NW-Bound]

Thanks for sharing the above.

As mentioned, I write covered calls on my long-term positions to get a bit more "dividend" off them. And I tend to do this when the stocks are at what I think is the top of their trading range.

I have been getting a few extra percent of return this way, which does not get me rich but is low-risk and fun. And often, I guess the top of the range correctly, and could have had more money if I just sold the stocks instead, then bought them back later lower.

With the recent dip, I still lost money overall with the stocks, but lost less with the gains from the options. In other words, my option trading just provides for a bit of hedging. I figure that if I tried to make money purely from option, it would be harder.

 

[TallTim]

Thanks @jldavid. That's a relatively decent/good approach.

To the OP, I'd second much of what is already here above in terms of getting educated (OIC, CBOE, all the major brokerages provide free training) and using a papermoney account to get started and see if you enjoy/can make $ trading options.

I've been actively trading options profitable for nearly 15 years. Started with simple covered calls and progressed from there to larger and more complex positions. Now generating substantial cash income in FIRE from that activity.

That said, I would add a few general guides in terms of what it takes and what to expect.

Though YMMV, I've found that in order to be good with options you need 3 main things:

(1) you need to be quantitative - or at least quant enough to understand options pricing and greeks

(2) you need to be disciplined - set and follow your own entry and exit points, and under no circumstances chase a trade

(3) be dispassionate about trading your own dollars -- many very good investors fall on this one b/c of the underlying moves that come (or can) with options

Further, in terms of what's doable/reasonable

(1) do not trade options with more than about 10% of your invested dollars if you're a beginner. Even as a relatively advanced trader, I do not trade more than 40-50% of my invested accounts.

(2) reasonable risk-adjusted return is around 1-2% per month of whatever size you're trading, and you will have losing trades in there. (E.g., actively trade $100k options account and you can reasonably collect $1-2k per month). If you're looking into a strategy that suggests more is achievable, then I'd respectfully suggest that (a) it's either extremely risky and/or (b) not repeatable b/c the result of some kind of black swan or secular trend/move that likely won't repeat.

All that said, it's fun and absorbing and if you're willing to learn, work and deal with ups and downs as noted above it can do very nicely.

Lots more detail behind all of these ideas, so ask away or PM me.

 

[fredberry]

I have traded options on and off for decades but only since October have I really used it to generate supplemental income. My liquid assets fall into three primary categories: T-Bills/money funds for cash, high quality dividend stocks (I do not write covered calls on these since I consider them the backbone of our monthly income) and money/stocks for what I call tactical or income investing. It is this last category that I trade options on.

Successful option traders have developed a 'system' that works for them. Here are some of my criteria (works for me but not necessarily for everyone!):

1. Option commissions will significantly affect your return unless your brokerage will give you 300-500 free trades over a couple of years. Both of my brokers did that for me so check with yours to see if that is an option (pardon the pun). Changing brokers or opening up a new account should get you a similar benefit.

2. I only sell options whether they are covered calls or cash-covered puts. I do not do strangles, iron butterflies, etc. (keep it simple stupid!).

3. I am not 'married' to my 'tactical' stocks. They are nothing more than a vehicle to make a few dollars here or there. Should a stock get 'called away' I consider the trade a success.

4. I pick stocks that have been 'beaten down' either because the sector is out of favor or the stock itself is out of favor or both. I prefer stocks from good, viable companies that are from $3-7 which limits my downside.

5. I will sometimes buy 1000 shares of a stock at a dip and sell it intra-day for .10 or more profit. Other times I will buy and then sell a covered call. Alternatively, I will sell a cash-covered put and should the stock 'be put to me' will turn around and sell the covered call at some point thereafter or the stock itself for a quick profit.

6. Rarely do I buy the option back. The majority of the time they expire worthless but I have no problem with the stock being assigned or taken away.

7. This approach will produce small frequent profits but it sacrifices any significant upward moves in the targeted stocks. When a stock becomes too expensive for me ($8 or more) I move on to other stocks.

8. All profit/loss is taxed as income.

9. I average between 6 and 15 transactions a month and have had only one loss of $50 (I bought the option by mistake rather than sold it.) So far I make a little more per month than my dividends from my core stocks.

10. I use Ally Financial to monitor real-time my target list of stocks and options. Ally does not require you to set up an account but just create a login to access this benefit. When I see activity on Ally that I want to act on I log into one of my brokerage accounts and post the trade after which I log off. I don't like staying logged onto my brokerage accounts nor do I use their real-time display trading platforms.

I agree with most of what has been posted in this thread especially from NW_Bound. What I have described here works for me but YMMV! Money management, stock picking, and discipline are key. But I live by the motto 'Sell too soon!!'

 

[fredberry]

I almost forgot. Be careful when buying or writing options on stocks near the time they will report earnings. The punishment for a 'so-so' earnings report is always much greater than the reward to a stellar one!!

 

[thefist]

What a great discussion.
I'd like to add a few items which I don't recall mentioned specifically herein:

1) You're buying or writing options on a company stock. Make sure it's a good one! Pick the stock first and the option second. So you need some way of determining value on that company. Maybe it's a company you already know/own that's had a good run (covered call), or a new company you WANT to own cheaper (written put). Don't bet on the duds or speculative.

2) Juicing your returns by something like 0.5% may not look like much, but if your withdrawal rate is 4%, that option premium earned makes it 3.5%. And that, seems to be a perpetually safe rate discussed ad nauseum in here.

3) I agree writing options is best, but buying long term options (LEAPS) on blue chip companies can be very profitable with reasonable risk. Just understand you're holding these perhaps as long as 18-24 months or slightly longer. So its long term, just not indefinite.

For instance, Apple dropped 33% from 225 to about 150 late in 2018.
Buying "in the money" calls expiring in Jan2020 or 2021 provide a way to get the stock return for less money. But size your position properly. If $20,000 is a stock position for you, that's a single option and stick with that discipline.
<for disclosure, I own AAPL but not this option>
In this example with apple at 150ish in late Dec2018, a Jan2020 120 call might have sold for $36 (30 in intrinsic value, and 6 time value premium), so at expiration the stock needs to be above 156 to make money. If you bought a 150 call, the premium would be much higher.
Because there is an expiration date, be careful on the entry point. Like I mentioned, looking for good entry points on blue chips such as AAPL, Walmart, Home Depot, Berkshire Hathaway, Intel, McDonalds, etc is needed. When the market takes everything down with it, stocks such as these can rise quickly back. Be patient.

 

[thefist]

Forgot to add that I learned via the Motley Fool Options service, beginning in 2009. This is still available today, but priced much higher. IMO, it is helpful to purchase training when it comes to options trading.

 

[napili50]

You could start with the appendix in malkiel's random walk book, and read the rest of the book about making money instead of trading options.

 

[SoReadyToRetire]

OP here. Thank you for the interesting discussion.

I'm not gonna touch these things with a 10-foot pole, and neither is my husband.

 

[OldShooter]

OP here. Thank you for the interesting discussion.

I'm not gonna touch these things with a 10-foot pole, and neither is my husband.

Wise decision IMO. You might hear from a few people who might be lucky, might have some skill, or might just be talking about their winners rather than their whole experience. You do not, however, hear so much from those who lost some or all of their money trying to beat the market in options. Nassim Taleb calls this the "silent evidence" that must nevertheless be considered. (https://johnaugust.com/2007/silent-evidence)