Opening the Option Trader's Toolbox - Part 1

02/26/2014 8:00 am EST

Focus: OPTIONS

Bob Lang

Founder and Chief Analyst, Explosive Options

Bob Lang of ExplosiveOptions.net shares some common-sense words of wisdom that option traders can use to up their trading game.

As a trader, you have more flexibility and freedom than you could imagine. The possibilities for creating a winning trade structure are endless, but if you don’t know the rules of the road, then you’re going to get hurt.

Many people out there have set goals for themselves, worked hard to achieve them and enjoyed the results. That is a great start. However, we don’t operate in a vacuum, and oftentimes our targets need an adjustment. How do we do this?

“What do you with a mistake: recognize it, admit it, learn from it, forget it?”
-Dean Smith

Unless you have some sort of crystal ball, you have no idea what the outcome will be. When we make a play, we must be aware of the risk involved. More importantly, we have to know our own risk tolerance level. Is it reasonable to lay it all on the line when a binary result is the only option? For the gambler, that may be just fine, but I prefer to be more strategic.

First of all, I will always leave my ego at the door. Trading is not a game of perfect.

Second, we have to keep moving, and that requires doing SOMETHING. Don’t just sit there! If you have a nice 50% gain in an options play, what do you do? Better yet, what CAN you do?

You have a lot of options, but you have to think through them. You can sell for a nice win. There is never any shame in that—nobody ever went broke taking a profit. You can roll up to a higher strike and go further out in time, simultaneously taking some capital off the table. You could buy a put for protection to create a strangle. You can sell an upside call, capture some premium, and create a vertical spread. You can do nothing and let it ride. You can sell half or part of it.

What if you’re sitting on a losing trade that is down 50%? Feels awful, doesn’t it, especially when the outcome is worse than you expect. What’s your next move?

There are repair strategies, like selling premium (calls or puts) to capture some of the cost, but oftentimes, a loser is just not worth holding onto. If you have rules in place to cut bait, then you just do it. There is no use leaving a trade open to look at a loser day after day until the option expires. I have even PAID the broker to get rid of a losing trade because I didn’t want to look at it any longer. Out of sight, out of mind. The next trade is the one that can make things better—always take the next trade.

“Be decisive. A wrong decision is generally less disastrous than indecision.
-Bernhard Langer

Understanding the potential outcomes of options trading is critical. This is a zero sum game, and if you’re on the wrong side of the fence, then you’re a loser. However, we can become smarter, more nimble, more flexible and more adaptable to certain situations while staying away from the ever-present dangers. As buyers of options, we are fighting decay at all times, yet we also have to be on target with direction. If you’re ready to make a move in the most optimum situation, then you’re way ahead of the game.

By Bob Lang of ExplosiveOptions.net

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