How to Become the Next Market Wizard

02/18/2013 6:00 am EST

Focus: STRATEGIES

Some of the great traders today made their fortunes trading products when they were new and had pricing inefficiencies, writes Brian Lund of BCLund.com, and you, too, can mimic that strategy.

A couple of weeks ago I watched a trader turn $483 dollars into over $150,000 in three days.

He was trading OTM weekly options in NFLX going into their earnings announcement, and despite how much of an outlier event this seems at first glance, I am starting to think that there might be more to weekly options than meets the eye.

Most people are familiar with the Market Wizard series of books by Jack Schwager, which provide a rare glimpse into the world of some of the greatest traders. Although the profiles are interesting, one of the major takeaways from those books, for me, is how many of those traders made their initial market fortunes.

Exploit Inefficiencies
Not an insignificant number of them made their money trading products like options, forex, and futures when they were new and pricing inefficiencies existed, which they then exploited. That is where I think weekly options are right now.

Still New
Weekly options are still relatively new and that fact combined with their extremely short life span, I believe, is providing a window of time where smart and aggressive traders can use them to garner outsized returns.

The irony is that most successful traders stay away from weekly options because they feel too much like a gamble. Traditional money management concepts that are used to trade equities or even longer dated monthly options don’t really work with weekly options. With those products you are trying for a 30-40% win rate and taking minimal losses on the other 60-70%. However with weekly options the win rates are more like 5-10% and you are likely losing your whole investment on the other 90-95% which are losers.

However, just a few wins in weekly options can more than make up for you losses; even if those losses are 95%+ of your trades.

Break it Down
Though it’s more like a lottery win, just for fun let’s look at that risk/reward ratio on that NFLX trade. It comes out to 1:310, which means you would, in theory, only need to win once out of 310 trades to break even. Yeah, crazy right?

But I have also seen a lot of 10, 20, 50, and even 100 baggers from weekly options traders as well. There is something going on with weekly options right now that I don’t think will be there in a year or two as more participants begin to use them and pricing inefficiencies disappear. I don’t know exactly what the strategy is for playing them successfully, but I am working on it, and you should probably be doing the same thing as well.

Who knows, if you figure it out in time, you may end up in a future edition of Market Wizards yourself.

By Brian Lund of BCLund.com

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