Recommended Option Strategies

When I discuss option strategies on
this blog, the emphasis will be on making money and managing risk.

The following are the methods I
recommend for investors who already understand how options work.  For
rookies, I recommend the same strategies, but it's important not to begin
trading any of them without first gaining a good understanding of how each of
these strategies works and what you are trying to accomplish when you adopt
them.

  • Covered call writing
  • Cash-secured naked put selling
  • Collars
  • Credit and debit spreads
  • Iron condors
  • Diagonal, and double diagonal, spreads

As I continue to write this blog, I'll
offer tips on each strategy and reply to your questions.

For readers anxious to learn much more
about these methods more quickly, my newest book The Rookie's Guide to Options teaches you (in
detail) how to use each of these methods.

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3 Responses to Recommended Option Strategies

  1. Michael S. 06/17/2008 at 9:22 AM #

    I have 2 questions on the subject of options that I hope you’d have the time to answer.
    You talked about comparing the implied volatility of the option with the historical volatility of the underlying stock to see if we are overpaying for the option. I noticed that many call options I am interested in buying have IVs above their underlying historical. How much can the IV be above the historical volatility before it’s considered risky to purchase?
    Is there another way to check if the IV is too high for a trade other than comparing the IV and historical? (for e.g. would applying ‘bollinger bands’ to the underlying help at all?)

  2. Mark Wolfinger 06/17/2008 at 11:03 AM #

    Hello Mike,
    As with many situations in the options world, there is no black and white answer. This one is gray.
    Consider these factors:
    1) The nature of some businesses change over time. Thus, it’s reasonable for the future volatility of a stock to change significantly from its past volatility – especially if you go back a few years to measure that volatility. Example: when a company grows and become mature, it is much less volatile than it was years ago: Microsoft and Intel are two examples.
    2) A news event may be pending. When that happens, it’s reasonable to anticipate that the stock is going to make a larger than normal move. That means it’s going to be more volatile right after the news is released. Under those conditions, you know that implied volatility(IV) is going to be higher than normal. How much should you be willing to pay? Also consider this: once the news is released, IV will immediately return to ‘normal’ levels because there is no longer any news pending. Do you want to own options knowing that IV is about to crash? You can afford to do that ONLY if you are very right on the direction and size of the move the stock makes. There are no specific rules to guide you in reaching that decision.
    3) You can also research the recent implied volatility of the stock. If the current IV is not higher than it’s recent level, it’s not ‘too high.’
    I don’t want it to appear that I am not giving you a straight answer, but there is much judgment that goes into knowing when to buy/sell options. But – if there is no special news pending, if the company is operating as it always has (as far as you can tell), then most of the time it’s a losing strategy to buy options when IV is elevated. Sure, you can win part of the time, but to succeed in the options world, long-term profitability is the name of the game.
    I don’t know much about Bollinger bands, but I don’t see how then can help with how much to pay for IV.

  3. Michael S. 06/17/2008 at 12:39 PM #

    Thank you for taking the time to answer this question. Very helpful!!