Tag Archives | directional play

Buying Options

Mark,

I see a lot of chatter on boards for the most part concerning short
sided (premium selling) neutral plays but don't come across nearly as much on directional
type trading. In theory, I understand because this is often considered a
"riskier" play.


I have found I have the best success trading on 4 -5 stocks (and 2
indexes) over and over again, as I seem to learn their movements and
ranges pretty well.
The stocks specifically have medium to low IV and trade pretty decently
within a range for the most part.   That helps me identify
when they are outside their top and bottom levels and probably due for a
reversal of some sort at some time.

Based on this I have been paper trading some long plays thru slightly
OTM calls or puts when stocks hit a high or low level.  This has turned out
quite well over the last few months. Much better return than my short
sided plays.

I'm going to take 10% of my capital and start placing real
funds in the game.


My question is this. I'm sure you've had much experience on the buying
side
. Any particular recommendations you may have on this strategy?
Better to be ATM, OTM, etc? (I'm using slightly OTM as in 1 strike away)


How many months out have you found best? (I'm going 2 months out
currently).

Any particular technical indicators or other analysis tools
you find to be helpful? (I currently am just basing when price swings
outside the normal range).

Not really sure exactly what questions I'm wanting to ask but more or
less get your "been there done that" feedback as to what has worked for
you in the past. Thanks.

Jason

***

Hello Jason,

You see most comments about premium selling because most traders understand that is the more profitable side over the longer term – IF, AND ONLY IF, ONE EXERCISES PRUDENT RISK MANAGEMENT.

Your 'style' is unusual.  Most traders who use technical analysis believe that when a stock is trading at a new high, it's right to buy, not get short.  Similarly, a new low is a signal
to sell. 


To your questions:

I have almost never bought options as a directional play, and I've been trading options since 1975.

I do buy options to add positive gamma to a position, but the purpose is to adjust another position – not to make a directional play.

However, I do have opinions:

1) Unless you are playing for either a very quick move or a substantial move, buying OTM options is a losing strategy

2) Is your total trading history for directional plays that 'few months' of paper trading?  I ask because when buying options you must have a proven ability to get the direction and timing right.  I note you are not so sure about timing.  'At some time' is not quite good enough for trading options.  Especially OTM options.

A few months experience is not nearly enough.  Maybe you had several good years picking stocks before you moved on to options?  But I do encourage you to go ahead with your 10% plan and see if you can make money on your idea.

Please go in with the understanding that the odds of success are very much against you – track record or no track record.  Just look at the mutual funds as one example.  They hire expensive professional traders, and those guys/gals cannot outperform the market averages.

Why do you believe you can do it?  If it were me, I'd want solid proof that I had the elusive talent to consistently get it right when picking stocks – before attempting to make money by buying OTM options.   

2) If cash is not an issue, I'd prefer to buy (one-strike) ITM options.  These don't lose much to time decay and immediately gain the major portion of the move (due to high delta).

If your plan is to use leverage and buy a 'bunch' of options, looking for a big win, then that requires you to buy options with a lower delta.  But I loathe that idea for myself.  It may work for you – if you have the talent mentioned previously.

3) I like the idea of two-month options, but to be honest, when making a forecast – and especially when buying options – being accurate on timing is essential.  That's why you should KNOW, and not ask, which option to buy based on timing of the move.

Lacking that timing instinct, you are just taking a chance, no matter which option expiration is chosen.

4) Going one step farther and being even more helpful (smile), I use zero technical indicators.  I know FOR A FACT that my stock market prognostications are not good, and I do not make directional plays.

5) I have never been 'there' and I have never done 'that.'  But I hope this reply is helpful

736

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