One thing I have noticed in my journey into options trading is that while most mentors teach novice traders to use strategy A in up markets and strategy B in down markets and strategy C in sideways markets I utilized these rules and I was not impressed with my results. Additionally it seemed to me that the traders who truly traded for a living and were very successful didn’t follow these rules.
It was only after reading several very boring, wordy books, actively trading multiple different trading strategies and completing three online options courses. That I had the good fortune that my last mentor said two things which were invaluable to me. He said there are many different strategies in options trading and every trader has their favorite and they will try to convince you that their favorite strategy is the best. The truth is there is no one best strategy. The truth is that every strategy has its strengths, weaknesses and nuances. But what is important is how our individual brain understands those three things and that is how our brain uses a particular strategy to reach our highest probability of success repeatedly and minimize the risk of loss of our capitol.
It is important to realize that all our brains are different and we see things differently based on the knowledge, skill and experience we bring to the table. Because of these differences it will be natural that some of us will excel at covered calls, others at iron condors, other vertical call spreads and yet another vertical put spreads. We will frequently say that a particular strategy just clicked with us. I believe each of us can be very successful and in time can excel at a strategy that just clicks and our brain is in tune with.
For example there is your classic wide winged iron condor and there are 3-4 variations. These trades are interesting to set up, they are classically employed in high VIX or volatility environments and in stocks or index’s trading in a well defined range or sideways.
But they can fail miserably in a sudden market change to a bull or bear market and a stock or index starts trading outside its range. Which usually means near to your strike price or blowing right past it. But to traders who lover iron condors this fiseaster is also an opportunity. Remember you can still profit from the volatility and it’s effect on option premiums. Plus the market cannot be both bullish or bearish and you can move your strikes before expiration to minimize losses, maximize gains or roll the whole trade into the next month to give yourself more time to be right about market direction or a stock or index’s movement.
Now to some of you, what I said about iron condors will just click. You will understand it and in your mind see how that works not just in theory but practice. Now truth be told it may take years to become a successful options trader, but some will seem to be natural born traders after a short period of time. I think these natural born options traders learned all the nuances of a particular strategy so that they could use it or it’s mirror in multiple types of markets. You see even a bullish trading strategy has a mirror trade, which works in bearish times. You just need to understand the nuances.
For example, option spread traders love to sell out of the money put spreads in bear markets. It’s a good strategy because a bear market makes investors afraid, this fear is reflected in the market in the form of large put premiums and correspondingly a high VIX index. Thus put premiums get fat and as they are out of the money , they have large extrinsic or time vslue, thus a correspondingly high theta, so while the spreads sell for a nice credit, theta eats away at the options value rapidly and in a few weeks, the option prices are so low it’s easy to buy back the spread for a much lower price and make a nice profit. So those are out of the money put spreads, which traders love to sell during bear markets. But did you know you can make money on the mirror trade? Yes, in the money put spreads are great money makers in a bull market, because in the money puts have much larger intrinsic value then extrinsic or time value so their theta is small and they retain their value. Plus they are in the money, which frequently corresponds to large deltas, so they have near dollar for dollar gains with the stock or index, so their appreciation is high. Add to this a large payment multiple and low loss risk due to large premiums and you have 20:1 leverage with low capitol at risk despite spread size between front and back months. There are multiple nuances at play including 45-60 day expirations. But this is a perfect example of a strategy being tweaked for use in both bull and bear markets and a good trade is chosen by picking the strikes with favorable deltas, thetas, expirations date, and both high reward and low possible loss.
There are of course other nuances which increase your risk of loss, like a propensity towards early exercise risk. This can be dealt with by deploying this strategy only in the SPX and watching ex-dividend dates closely in the SPY since early exercises can cluster around ex-officious dates. And nervous buyers exercise their options.
I hope I got through to you with this post. And you understand the importance of understanding your chosen trade strategy well, manipulating its strengths and weaknesses to your benefit and remembering the most important rule in options trading. Which is that good trades are created at the beginning of a trade.
In short, the best strategy is the one your brain understands the best and it’s this understanding which will make you the most profit. I think it’s good to find someone who has mastered one trading strategy and employs it almost exclusively and if they mentor you, you receive wisdom worth much gold. Stop searching for the best option strategy, instead learn several but focus on one which your brain understands well. You will know this I think because not only will you understand it easily, but also understand and employ changes to improve the strategies design.