How to choose the right options trading method according to your risk appetite.
Options trading is well known for its leverage and versatility. Through
its hundreds of options trading strategies as well as countless ways of exploiting
its leverage, options trading can be adapted for any trading style and any
trading objective. Since it is so versatile, how should an options trader
choose the most profitable way to trade options?
Most options trading beginners read amazing stories about how some people
make millions trading options in a certain way and then try to duplicate what
those people do only to be greeted with defeated. Indeed, what works for others
may not work for you. Why is that so? It is because success in options trading
requires a matching of the right method with your risk appetite!
An options trader’s risk appetite decides when the options trader’s
emotional button, or panic button, gets hit. When the panic starts, everything
screws up. This is why options trading methods that work for some people don’t
work for others.
Below, I shall provide a general guideline on what options trading method
matches each kind of risk appetite and fund size.
Big Fund, Big Risk Appetite
When you have a big fund and a big risk appetite, you might want to
optimize your returns by swing trading with options using the majority of your fund.
You may also use a smaller portion of your fund to place out of
the money bull call
spreads or bear put
spreads on stocks that are likely to stage a significant breakout due to
earnings release or take-over.
Big Fund, Small Risk Appetite
Most options traders fall into this category and are people with hard
earned savings who aim to make a small reliable income while taking as little
risk as possible. Such people should use low risk position trading strategies
such as Covered
Calls or the Ride
The Flow strategy in order to produce a small residual income monthly
without the need for active trading.
Small Fund, Big Risk Appetite
If you have a relatively small fund and is willing to take big risks with
it, you may wish to day trade options by identifying stocks that will move
within a day and then maximize your exposure using in the money
options, selling them the moment the stock turn against you within the day
itself and then move on to identifying other opportunities, all within a single
day. The aim is to make as many profitable trades within a day and stop if your
loss limit is hit for the day. This strategy is not that productive for bigger
funds due to the relatively low level of liquidity of options which may not be
able to fill extremely big positions quickly.
Small Fund, Small Risk Appetite
Oddly enough, many people fall into this category as well. If you only
have a small fund and you cannot afford to take much risk, you may want to buy
long term (expiring one year later) in the money LEAPS call options on
good quality growth stocks simply as a leveraged replacement for stocks. LEAPS
call options which are deep in the money moves almost dollar for dollar with
the underlying stock while costing only a fraction of the price. Small funds
will not be able to reap the benefits of position trading as much as bigger
funds can due to commissions and spread loss.
Following these general guidelines along with your specific
considerations and unique situation, you may be able to choose a sensible
approach to options trading which will truly benefit you for the long term.
Find out more about options day trading, swing trading and position trading.
