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Why Option Spreads are the Best Trade
12/06/2012 3:27 pm EST
Learn how you can be "partially right" and still make money using non-directional option trades from Kerry Given.
Equity traders know that for the most part you have to be right in your trade, 100%, right, to make money but option traders have a different view. You can be partially right on your idea and still make money. My guest today is Kerry Given to talk about that. So you know that with option trades you can be sort of right within a range and still make money, non-directional trading. Why is that such a benefit to traders?
As you pointed out, most people get into options from stock trading, and of course, in stock trading you’re always predicting the price and the direction, and if you’re right you make money, if you aren’t, you don’t, and in options trading as you point out you can do a directional trade, but you can also trade non-directionally and what I mean by that is not just necessarily sideways trading. You can put on your position and then manage it to adjust, based on what the market does today. So the big distinction I make is that you need to react to what the market does today rather than predicting what it’s going to do tomorrow.
Talk about an example of a good non-directional trade that traders put on that’s popular.
Well a couple of good examples are the iron condor and also butterflies. Both can be used that way. In both cases you need to have some kind of method that you’re going to use to adjust this trade if the market moves up or down against you and so as long as you have that adjustment technique and manage the trade then you can manage the risk.
Give me an idea of what an iron condor is made up of. What are you doing?
What you do is you sell a call spread up above the index price and you sell a put spread down below it and basically your trade will profit as long as it stays in between those two spreads and what you might do is if the index starts to move say downward, then you might add a put and that would even out your risk on the downside so if it continues to move down against your put spread your put spread’s losing money, but the put that you put on is gaining money and so in affect you moderate your losses that way by those adjustments.
Newer option traders seem to, of course, start out with maybe a covered call or buying calls or buying puts but at some point along the evolution they quickly move to the spreads because they seem to be the real way that professionals make money with options. Would you agree with that?
Absolutely, you not only increase your possibilities of better, larger gains but you also have a lot better risk control. You have more options or alternatives for how you’re going to manage your risk.
And these days the trading platforms make it pretty easy. You can put all these trades on at once with some of these platforms.That’s right and usually they have very nice tools to graph the risk reward curves and so you can see exactly where you stand and where you need to make adjustments in order to change that risk.
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