Trading Options the Simple Way

01/17/2012 3:30 pm EST

Focus: OPTIONS

John Carter

Author, Mastering the Trade

Option trading doesn’t have to be complicated, says John Carter, who teaches some simple, yet profitable option trading strategies that work on a variety of stocks and ETFs.

Option trading can get a little bit complicated if you start to talk about different spreads, butterflies, wings, and all kinds of different things. It doesn’t have to be that complicated though.

Our guest today is John Carter to talk about option trading the simple way. So John, talk about how I can get into option trading. Does it have to be complicated?

And wings and ribs and thighs and all those things!

I come across a lot of people who come out of options courses armed to the teeth with 100 different strategies on how to trade options. You know, sawed-off-leg butterflies, iron condors, and all those kinds of different strategies, but what I find is they don’t completely understand, or even worse, they disregard what the underlying is setting up to do.

In my background, my mentors always taught me to first focus on strategies to get a general direction of a market and then apply option strategies based on that.

I just think a lot of people can make options strategies a lot more complicated. Unfortunately, what will happen also is that somebody attracted to options strategies that will make money 11 months out of 12, and on that 12th month, it just gets annihilated where you lose everything else.

I like to take an approach where I focus on direction, and if I am focusing on direction, I will like to focus on in-the-money options. For example, buying an option, a Delta-70 option, and just basing it on the underlying.

For example, if I see that Apple (AAPL) is at $380 and based on what I’m looking at, it looks like we can get a move up to $400, I’ll buy some 370 calls, assess how much I’m willing to risk, and then see if I can double the option. Pretty simple.

There are other strategies in that situation where you could do all these different iron condors and everything, and it’s great because it will make a little bit of money, but the losses are huge.

I just think it’s important to understand that something that may seem like low risk most of the time, actually, for that one time out of ten, the risk is so big that it’s not really worth doing, I don’t think.

You’re looking at the option “Greeks,” you’ve got the option chain; how long did it take you to kind of get confident reading all this information and pick the right option for your strategy?

The thing with options is it’s very easy to get too complicated too fast.

For the Greeks, if primarily all you do is sell premium, then yes, you’ve got to get the Greeks nailed. You’ve got to make sure you’ve got the implied volatility where you want it and different things like that.

See related: Know Your Option “Greeks”

If you’re more directionally-based, though, it does rely more on just the underlying action of the stock.

NEXT: Spot the Most Favorable Option Set-ups

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For example, set-ups like squeezes that are about to create a lot of momentum. I look for stocks that are in a quiet period: the implied volatility is low and there’s no major events coming. During that time, you can accumulate—like in that situation with Apple—in-the-money calls, and then when it breaks out and gets the momentum, you have two things going for you.

You have the momentum, you’ve got the price obviously going higher (that’s going to help the option), but because now momentum has come back to that stock, the implied volatility also expands.

So you have a win/win there because you’re making money on the actual direction of the stock. You’re also expanding the premium because now we’re back in business again and the market is moving and the implied volatility expands.

That’s what I really like to focus on because then if I’m wrong, I can set exactly how much I’m willing to lose as well.

You mentioned the strike price and that you like slightly in the money or in the money. How about the expiration month? How far out do you like to have them?

I actually really prefer a closer-month option. You know, a stock like Apple with high volatility, if you’re going out three or four months, you are really paying a high premium for that.

I would rather, for something like Apple that also has the weekly options, one of my favorite trades right now is where you can sit there and three weeks out buy a monthly in-the-money call. Then every week, especially on that first Friday when that weekly option is trading, I’ll sell a two-strike out-of-the-money option.

The premium is really high. The Gamma at that point is really high, and you’ve got this super price. The weekend comes along, and you’ve already lost some of that implied volatility, and bam, you’re already gaining some money there.

In a perfect world, you buy your option that’s three weeks out. You can sell against that three weeks in a row. It pays for itself and then you keep what’s left over.

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