Options Education for Individual Investors

Here's what I believe. You may find it helpful in your own trading.

My Personal Trading Philosophy

This is what helps me make money trading options. It may or may not prove helpful to you

I find the more closely I adhere to these basic beliefs, the more profitable my trading. Sometimes it's difficult to make the correct choice because human nature tells us that "this time it's different. This time you can take a chance because it's going to work out well." And if it does work out profitably, that's not a good thing because it may encourage you to violate the principles of sound trading next time, and the time after that.

When you make the decision to adjust or close a position that would have been a winner had you done nothing, don't kick yourself. Your job, as a risk manager who wants to make money, is to make the best decision you can - at the time the decision must be made. Looking back and saying that you could have, or should have done something different based on the result is a mistake. You should base your decision on:

  • Is this position too risky for you right now?
  • Is the potential loss more than you are willing to accept?
  • Is the remaining reward too small to continue to hold the position, or should you take your profit at this point?

Basic Tenets - in Pairs

  • It's easy to make money with the option strategies I describe.
  • The difficult part is keeping those profits.

  • Choosing an appropriate strategy (or two) is important.
  • It's far more important to manage risk.

  • Profitable positions are considered to be easier to manage than losing positions. That's true to a point, but don't get complacent.

    • The money earned from a winning trade is your money.

    • Profitable trades must be monitored for risk because those profits (your money) can quickly disappear.

    • When the remaining profit potential is small (a relative term), it's often wise to close the position, take your profit, and eliminate the ever-increasing risk.

  • Losing positions must be managed carefully to prevent a small loss from becoming a large loss.
  • Do not allow a position to move against you so far that it has exited your comfort zone.

  • It's important to always trade within your comfort zone . That means:

    • Being comfortable with both the potential risk and potential reward of a position at the time it is opened.
    • Being comfortable with the risk and reward of the position after it becomes part of your portfolio.

  • Comfort zones should be flexible over time. That does not mean taking on more risk just because you have trading experience, but it does mean that it's appropriate to change your basic methods as market conditions change. For example, bullish strategies such as writing covered calls may make you uncomfortable (for good reason) when the market is bearish and you may prefer to trade iron condors instead. That's why it's a good idea to be aware of alternative strategies, even when you have no immediate intention of adopting any of them. They become part of your arsenal of useful trading tools.

  • Dr. Brett Steenbargen, whose expertise is trading psychology, makes this point very well in his trading blog (dated May 17, 2008) "It's difficult to succeed at trading, but--given rapidly changing market conditions --even more difficult to sustain success. It's not good enough to find winning trading techniques; one has to continually adapt these techniques to an ever-changing environment."

  • Jeff White, in his blog espouses a similar philosophy for day traders.

  • John Foreman, in his Essentials of Trading blog, likes to 'poke hole' at traders who post ironclad trading rules based on false assumptions.

  • When your comfort zone is violated, do not just close your eyes and hope something good happens.

    • Reduce your risk by adjusting the position. Thus:
    • Close the position, or reduce the position, or buy insurance for the position. It may be appropriate to close the position and open another in a different expiration month (rolling the position). But the important part is that your new position (if any) must put you back within your comfort zone.

  • When you sell options, or option spreads, it's prudent not to wait for expiration. Let someone else have the last few nickels.
  • At some point, the remaining profit potential (and that's all it is: potential) is just too small for the risk involved.

  • *****

    My Advice To Option Rookies

    • Don't trade with real money before you are ready.

    • You have the rest of your lifetime to trade options. Have a bit of patience now.

    • Understand that if you buy options, it's very difficult to make money consistently. Too many good things must happen for you to succeed.

    • If you decide to sell options (as I encourage), do not sell naked options. That means for every option you sell, buy a less expensive option to prevent huge losses. If you adopt this strategy, you will be selling credit spreads.

      • One possible exception is the sale of naked put options - but ONLY do that if you are willing to buy the stock in the event you are assigned an exercise notice.

    • Be certain you understand the important role that volatility plays in determining the price of an option. Do not believe that whenever you buy or sell an option that you are paying or receiving a reasonable price.


    If you agree with the thoughts expressed on this page, then you will benefit by learning about options the way I present the material in The Rookie's Guide to Options. Learn the reasoning behind the thoughts presented on this page.

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