Realities of Full-Time Option Trading

05/10/2011 10:00 am EST

Focus: OPTIONS

Mark Wolfinger

Educator, MDWoptions

Too many overconfident newbies serve as cannon fodder for the more experienced, patient traders. But if you enter this industry prepared and with reasonable expectations, you may be able to make a comfortable living.

How much can I expect to earn trading options?

What is a reasonable return on my option investment?

How long will it take before I can become a profitable option trader?

These are commonly asked questions. Most new option traders make the incorrect assumption that they will be successful, and the only question is how much they should anticipate earning.

A reader once asked me whether he could expect to earn a sufficient living and support himself in retirement when trading options. How much money did he have to invest? $5,000!

The unfortunate man thought that he could earn between 60% and 100% per month—every month—with no losses that would eradicate his account. And this is assuming that he would consider $3,000 to $5,000 per month to be a “living.”

Obviously such a dream is just that: An unachievable goal.

However, it is a legitimate question. Suppose an experienced trader—someone who is earning money on his/her option trades—wants to consider becoming a professional trader and perhaps quit the day job to trade full-time. Surely income expectation is a very important consideration.

For example, here’s a question I recently received via e-mail and my response:

“Hi Mark, I have some personal questions for you—what average annual return did you get when trading “full-time”, what return is reasonable to expect (assuming a number of losing trades of course) when trading semi-aggressive, not too conservative (trading 15-delta iron condors)? My desired, ideal annual return is 20%. I’m not talking about return on margin, ROI, I’m interested in average total returns. And the second question—did you have losing years selling spreads? Reason I ask that in some years I’m hoping to trade for a living and I’m still deciding (and trying) what financial vehicles and strategies work best for me. Thank you.”

My Response
I’m glad that you are considering this plan at least a few years before being ready to take the step. You want a chance to build capital and be certain you are ready to give up your employment. Some of my reply is personal, but it’s the truth.

I spent years writing covered calls, because my broker would not allow me to sell cash-secured puts, and I was not yet a fan of iron condors. Thus, my ROI is meaningless to you, because that strategy is very dependent on picking decent stocks and in choosing how aggressive to be when writing options.

I always wrote in-the-money (ITM) calls. I did well, but got crushed in the technology bubble. Years later, when I switched to iron condors, I earned a profit for 14 consecutive months, and I do not trade the very high probability spreads (85% to 90%).

That winning streak will not happen again in my lifetime. Losses are part of the game. I don’t really have a good answer on what you should expect.

I read your descriptive words, but they mean different things to different people. “Conservative” is a tricky word, and what you consider to be semi-aggressive could be outrageously dangerous to someone else. But let me tell you this:

  • Sometimes the markets are perfect for iron condors. The markets move up and down, but not too far, and eventually you exit the trade with a good profit
  • In this scenario, I have been able to earn more than 20% (of the value of my entire account; not ROI) in a single month. I assure you that this did not happen too often.
  • When the markets are good, we must take what they offer.
  • To me, that does not suggest being greedy. I try to trade 90-day iron condors and collect about $300 for ten-point RUT IC—$270 to $350.
  • I still cover the “little guys” when the spread gets down to 20 cents. I may bid 15 cents part of the time. Today I am bidding 25 cents to try to close some July call spreads.
  • When the market gets volatile, everything changes. The rock-solid income stream evaporates and you can lose a lot of money in a hurry. What should you do? You can sit on the sidelines. You can cut position size. You may prefer to adjust quickly when you sniff trouble. But you must change something about the way you trade. And it is especially important to recognize that the easy-profit days have gone. They will return, but you will not know when.
  • It’s easy to make money with iron condors. I’ve said that before
  • However, it is easier to lose money trading iron condors—and it’s far too easy to lose it in big chunks.
  • That’s why risk management is vital. You can be a little stubborn, but only a little. Over-confidence from winning streaks can cause a lot of damage

Regarding the “conservative” (15-delta) iron condors, I don’t consider these to be too conservative. Although I frequently trade 15- to 17-delta iron condors (IC) with the individual call and put delta of the option being sold in that delta range, I would certainly classify that as semi-aggressive.

Trading 15-delta iron condors would result in maximum profits (all options expire worthless) 70% of the time—if you close your eyes and hold to the end. I hope you know better than to try to do that.

NEXT: Is a 20% Return Possible?

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Is a 20% Return Possible?
That return would be considered “supercalifragilisticexpialidocious” by almost every experienced option trader on the planet. It’s the kind of result achieved on a consistent basis only occasionally, and by the world’s best traders.

A trader cannot enter into the game as a professional with such expectations. If it were easy, everyone would be in this game.

Yet, I believe it is achievable, even if far from guaranteed. It takes capital. You must allow for losing streaks and drawdowns. You must have sufficient capital. If you are forced to withdraw money for living expenses at the same time you are losing, you may not have sufficient capital to stay in business.

Please note that 20% of $250,000 is $50k. That’s real money, but is it enough for you and your lifestyle? If you spend all of it, then your account will not grow and you must earn that sum again and again. Be certain you have enough capital. Be certain you can survive if you earn less than your target.

I have not been able to average near 20% over the years. However, that does not mean you cannot.

To achieve that goal, I have one important suggestion: Make it your business to target a profit near your goal. Do not own positions where risk is too large, unless you trade less size. Do not fall into the trap of selling two delta options and collecting 30 to 40 cents for a ten-point iron condor.

I do suggest that you trade with an eye towards earning 2 to 3% per month, and not 10%. One problem with trading iron condors is that a winning streak makes the trader believe he or she is invincible—with the inevitable consequence of incurring a disaster.

My Opinion
You want to retire. You want to be a full-time trader. You must recognize and respect the risk of ruin (going broke).

To achieve your goals when trading iron condors, you must overcome greed. You must know when risk is just too great for the reward and give up the trade. This applies to exiting with a loss, as well as to buying back cheap positions (yes, it appears to be throwing money into the trash) to guard against the inevitable surprise.

You must trade appropriate size and not build gigantic positions just because the world looks glorious for the iron-condor trader.

This is not easy. But you want something special in life. You want a job you love and plenty of money. This is not a gift. It must be earned.

Once you and I have gone as far as we can go in teaching you about how to have a reasonable chance to achieve your dreams, you may do well to see a personal mentor or trading coach. But let’s talk at that time. You do not want to choose randomly.

And about those pesky “losing years” you mentioned. We all have losing months. But what about losing years? I’ve had plenty of them.

I know it is all related to risk. I understand that things looked good or that I mismanaged risk. If you can avoid that—if you can avoid being greedy “just this one time”—you can do it. I wish I were young enough to tackle trading with just that mindset.

I don’t mind sharing my story. I do not advertise myself as an expert trader who makes millions (although I did earn more than $1 million in each of two different years when I was a CBOE market maker). Being a market maker and being a retail trader are two different worlds, and there is no reasonable way to compare them.

The fact that I do not earn millions today is the major reason behind stressing the importance of risk management to people who work with me in my premium service or who read my blog posts.

Risk management is the whole ballgame. If you do not pay attention to that aspect of trading, or if you decide you can postpone thinking about that topic for a few years, you would be making a huge mistake. There is a good chance that your trading career would end abruptly.

As a market maker, I had the services of risk managers. These are people who knew what they were doing, but I had that ego of a winning trader. I was warned—more than once. I had people pleading with me to recognize what can go wrong.

“What do you know?” I thought.

Well, the answer is that they knew the truth. They knew statistics. They understood reality. And this was before 1987—when most of the world first came to understand that markets do not follow normal bell-shaped distributions, and the tails of the curve (especially downward tails) occur far more often than predicted.

Sure, others understood that concept earlier, but the reality of October 1987 brought it home to everyone.

These risk managers knew, but were unable to teach me. Now I know and am trying to teach others. Risk management is the whole ballgame.

More commentary from Mark Wolfinger can be found at Options For Rookies.

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