Question & Answer #2. How long does it take to be profitable?

On
June 17,
2008
George posted this question: “How long is the learning curve to using
options, and when can I expect to become profitable?

Hello George,

It’s important to understand that not
everyone who uses options does so to make money. Sometimes options are used as insurance to
protect the value of a stock market portfolio. As with other types of
insurance, that protection costs money and there are no profits.

 

But let’s assume you want to learn to adopt option
strategies to make some money.

1) The learning
curve. It doesn’t take very long (less
than one hour) to get a good understanding of what an option is and how an
option works. Thus, an investor can easily grasp the fundamental concepts of
options. But, it does take longer to fully understand one or more of the
possible strategies you can use.

There is no single best strategy for
everyone, but I recommend that you begin with covered call writing because it’s
the option strategy that is most similar to what you already  know: how to buy and sell stocks.  More importantly, this strategy is less risky
than simply buying and holding stocks. There are various places where you can
learn how to adopt  this
strategy. Of course, I recommend my
book, The Rookie’s Guide to Options, but if you search the internet, you will
find alternatives.

Once you have some practice using this
method – either with real money or in a paper trading (practice) account, you
will be ready to consider alternative methods –  strategies that involve reducing risk even further.

As to how long will it take to be
profitable using covered call writing, the answer is: how good are you are
picking stocks? Covered call writing is
a bullish strategy that increases  your
chances of earning a profit from every trade. But if you are a poor stock
picker, or if the market tumbles, you will not do well.  But fear not – there are other strategies that  cater to poor stock pickers and bear
markets. You may prefer to learn one of those instead.

2) When
profitable? Adopting the option
strategies that I recommend (and that does NOT include buying options) is
nothing like day-trading stocks. You don’t have to read charts (although it can
be helpful) or time the markets. These strategies involve holding positions for
anywhere from two weeks to a few months. If you choose strategies in which you are predicting market direction,
then your profitability depends on how skillful you are at knowing when markets
will rise and fall. If you choose strategies (recommended) that are market
neutral, you will do well most of the time, running into trouble only when the
market makes a big move. If you learn to
manage risk – an essential part of your education – you will be able to handle
problems when they arise.

Bottom line: You can be profitable from the
start of your option trading career. In
fact, if you adopt my recommended methods you will
profit most of the time. To be a
successful trader, you must be certain that you also learn how to manage risk
and keep all losses small enough to not overwhelm profits. Risk management is an important topic and
requires more time to learn than it takes to master a few option strategies.

Remember, you have your entire lifetime to
trade options. Have a little bit of
patience and begin by trading with fake money in a paper-trading account. When you feel confident that you understand
what you are doing, it’s time to trade with real money. Best of luck to you.

6

2 Responses to Question & Answer #2. How long does it take to be profitable?

  1. Michael S. 06/24/2008 at 6:01 AM #

    I have followed a strategy where I will close a position if I have more than a 6-7% loss. Is it right to say that it’s better to set a maxinum of 6-7% on the stop loss? On the other hand, what do you recommend as a good exit point to lock in profits? Would 8 percent be alright or do you believe that is getting greedy? Thanks!

  2. Mark Wolfinger 06/24/2008 at 6:42 AM #

    When trading options, it not easy to decide how much of a loss is reasonable before closing a position. To me the decision should be based on the risk/reward potential of the current position and the likelihood of attaining a profit if you continue to hold.
    When you buy options, it’s even more precarious. Time decay works against you and if your stock does not move in the right direction quickly, your option decreases in value. Unless your expectation for the stock has changed, it’s difficult to sell the option just because time has passed.
    Because buying options is a very difficult path to making money and most option buyers have more losing trades than winners, I’d say that 8% is far too little to accept as a profit goal. I don’t have any number to suggest because your goal should be to trade withing your comfort zone. But, if insist on buying options, give yourself a chance to be an overall winner and accepting 8% gains will not do it for you.
    When selling options, it’s crucial not to allow losses to hurt. If 6-7% loss works for you, that’s ok. But it’s going to mean closing out a lot of positions too soon. You should give yourself more room in my opinion. But it’s your money and you must be comfortable with the risk/reward profile of your portfolio. Selling options leads to more frequent profits than buying options, so it’s a good idea to close profitable trades before expiration arrives. But, 8% feels too low to me. I’d be more inclined to look for 50% or more of the premium to erode before closing – unless the underlying stock has moved enough to make you uncomfortable with the risk of continuing to hold.