OPTIONS

I recently received an e-mail from an option trader asking about the realities of trading options for income. They were good questions I have heard many traders ask in the past, so I thought I’d share my answers with MoneyShow.com readers:

First, the questions:

“My goal is to earn $2,000 per month (before taxes, commissions, etc.) beginning in January 2012 and to stay at this goal for at least a year before raising my expectations. (This goal is not set in stone and can be changed.) This gives me six more months to learn and practice. During this six months (also not cut in stone):

  1. Should trading be limited to strictly paper trading or is there an advantage to trading very small sizes with real money?
  2. Should I limit the number of strategies that I am trying to learn?
  3. Should I limit myself to the number of trades that I put on each month? For example, one credit spread and one iron condor per month (10 lot paper trades)?
  4. I have adopted a stop loss plan of losing no more than the amount of my collected premium. For example, if I collected $850.00 (on a 10 lot paper trade) then when the underlying goes against me to the point of $850.00 the trade is closed. Is this a realistic starting point? Thanks, Jim”

Jim,

It’s good to set a goal for yourself. However, let’s be reasonable. First you must prove to the world that you can earn anything. Not everyone makes it as a trader.

Had you asked, I would have suggested a smaller goal. Some people would be happy to meet expenses the first year. Note this: Month one, you are a novice. Months 11 and 12, you are a more seasoned trader. Still a rookie, but surely more knowledgeable than when you began. That should make a difference in your performance.

Please remember that trading is not a consistent flow of money. There are good, better, and losing months. Sometimes you cannot meet your target. Expect that. Do not allow it to disappoint you.

If you make bad trades (ignoring trades that are clearly superior) you are not going to do well. Thus, you may have a monetary goal–but it is far more important to have a learning goal. Making money is not a guarantee that you are skilled and not just lucky.

And the same goes when losing. It’s important to know whether you were unlucky or making mistakes. This is not always easy to judge.

$2,000/month is a meaningless number. If you have a $20,000 account, you have no chance. None at all. Don’t even try. That’s 10% per month.

If you have a $1M account, then $2,000/month is not worth the risk. You can do as well at the bank.

Thus, the size of your account matters. Please do not target more than 2% per month and I’d urge you to target 1%. I am talking about now, not for all time.

Some months will offer greater opportunity and others will offer less. That’s the way it is. Sometimes you will like the available trades; at other times you may decide to sit on the sidelines. Winning traders do not force trades. When undecided, trade half (or less) normal size.

NEXT: Answers to the Four Questions