Trader’s Mindset Series I. How Much can I Earn when Trading Options?

Over the past week, I've encountered a group of questions and comments from traders that tells me that traders have a certain way of viewing the world.  These each represent part of the Trader's Mindset.  I've already responded to some of the questions, while others remain on the 'to do' list.

Today I'll tackle one of those questions:  How much can I expect to earn when using options?

I plan to reply to each question and will group them as part of the Trader Mindset Series.  Taken together, they represent how one  trading professional, but psychology amateur, views the psychology of how trader's think.

***

I understand the thought process behind today's question, but it always disturbs me.  It's just the wrong question.  It would be better to ask any of these:

  • How much time should I expect to devote to my options education before expecting to earn money?
  • How much cash do I need before opening an options trading account?
  • Do most new option traders find success?  Or do most give up?
  •  I've never traded stocks or anything else.  Will that make it difficult to learn to trade options?
  • Should I learn to trade options or pay someone else to trade for me?

These questions  demonstrate that the person who wants to become an options trader recognizes that this is not a gimmie, and that some time and effort must be expended before rewards can be expected.  The commonly asked question: 'How much can I earn?' suggests to me that the person asking 'knows' success is easy, and that the only thing holding him/her back from joining the game is wondering whether it's worthwhile. 

I seldom, if ever, receive a question along these lines: 'What does it take to succeed?'   It's always similar to: 'I'm going to succeed.  How much can I make?'

***

A recent letter from Jo:

Hi Mark,

Is it possible for an ordinary person to generate income from trading options if they are able to sustain themselves for a few months without a job while they learn the ropes? How much can one hope to earn through trading options on the conservative side, and how long does it take to become an expert on average?

Is it necessary to purchase special software for options trading (technical indicators and such)?

Thank you,

Jo

***

Yes.  It can be done.  You can generate income.  However, when you 'need' the money for living expenses, it often places too much pressure on the investor/trader to succeed, and succeed right now.  That added pressure can will lead to poor trading decisions.  I know you understand. And that's why you plan to have 'a few months' cash in reserve.

The good news is that you recognize that profits do not begin from day one.  The not so good news is that you are asking whether it's reasonable to learn enough to make a living – during those few months.  The first answer is that every student has a different ability to learn and some just have a better aptitute and can understand how options work more quickly than others.  So yes, it is possible to produce earnings within that time slot.  But not everyone can move that quickly.

To succeed, you must understand what you are trading, and that means taking time to learn options basics. You should have no trouble understanding that options are different from other trading vehicles.

But I must warn you that some traders never get the special characteristics of options and mistakenly believe that they can be traded as if they were stocks. Options are different.  Not difficult to understand, but they are different. 

If you are brand new to trading, that means there is even more to learn, including basic things such as how to enter an order, how to use your broker's trading platform, the different order types (market, limit, stop etc.).  Someone with stock trading experience is already familiar with those items.

Discipline

In addition to how options work, the trader must possess (or be able to develop) certain personality traits.

Jo, if you are willing to learn how options work, and if you believe you can demonstrate the traits listed below, then you may very well be able to succeed.  No guarantees.

I do want to mention one important point.  if you expect to make money (income) by buying options and then selling them for profits, let me tell you that this is an almost impossible path.  When earning an income stream, the methodof choice is to adopt specific option selling strategies – all with limited risk.

Anyone can trade.  Anyone can enter the arena and place his/her bets.  But to have a chance of making money on a consitent basis, the trader must have

  • Discipline
  • The ability to recognize risk
    • how much money is at stake for a given trade
    • the probability of losing money
  • Patience to learn before trading
  • Patience to practice what you have learned, usually in a paper-trading account
  • Ability to control your feelings.
    • Fear leads to panic, which results in terrible decision making
    • Greed has you taking too much risk for too little reward
    • Pride has you refusing to recognize that you made a bad trade and must accept a loss
  • Recognize that a few successful trades does not make you a star trader
  • Understanding that you cannot make money every month
  • Understanding that low probability events do occur – just as statistically predicted
  • Recognize that a 90% chance of winning means there is a  very real 10% chance of losing
  • Accept the fact that you cannot make much money when you only have a small sum to invest
  • Knowledge that luck plays a role, and your job is to manage risk when luck is bad


Now, to your Question: How much can you make?

If you trade high risk strategies, you have a chance to earn a large sum (10+% per month), but that comes with a very high probability of going broke.  High rewards come with high risk.

If you are more conservative (as you are), you may try to earn 'only 2-3%' per month.  That's a very good return. Most professional traders cannot earn that much.  Brett Steenbarger once told me that the best professional traders earn 'in the low (emphasis on low) double digits' per year.  That sounds right to me.

Going by that, earning 1% per month is a realistic target.

However, to give you a better answer, I must ask: How much cash do you have for trading?  This is a key question that most beginners ignore.  They assume they can earn the same amount of money, no matter how much cash is in the account.  This is a huge fallacy. Why?  When you begin with a small sum, the risk of ruin, or the probability of going broke, is very large.  When you have extra cash, you can withstand a string of small losses and still stay in the game.

Also: When you have a small accout, if you have outstanding success and double the account in one year, the total dollars earned is small.  It does take money to make money.

Thus, I repeat, how much cash do you have?  If you have $10,000 and can do an excellent job and earn 2% every month, that's a grand total of $200/month.  That will not take you very far.  I assume you would want to earn a minimum of 10 to 20x that amount.  To do that you would have to take big gambles.  There's a chance that you could have a nice win streak and quadruple your money in a year or so.  But the most likely outcome of seeking such huge returns is the loss of all your capital.

Yes Jo, you can do it.  If you have the patience.  If you take the time to learn and are not rushed into trading.  And if you have sufficient capital to give you a realistic chance.  If you lack the capital, you can still learn and trade part time.  If you grow the account, if you save more cash over the years, if you show the talent and discipline, you may eventually have enough to try trading full time.

I wish I could offer better encouragement, but trading is not a business for everyone.  Being a successful investor can be very rewarding over the years.  Trading full time is different.

 

Becoming an Expert

On average, far more traders go broke than become experts.  Very few become experts. This question depicts another trader mindset that I believe demonstrates no conception of reality.  How long does it take to become an expert?  A lifetime. 

Experts are few and far between – assuming that by 'expert' you are referring to someone who knows how to make money and then actually makes it and keep it.  With that definition, few are experts.

Trading is a game in which you are continually learning.  And that's important because markets change over time and if you still do whatever it is that you are an expert at doing, eventually it will no longer work and you will cease being an expert.

It is not necessary to become an expert. You do not have to earn more than the next guy.  In my opinion, you can do well (earn decent income) if:

  • You have the ability to understand how options work.  This is not difficult, but some people just don't have the head for it
  • Trade with discipline and overcome emotions.  Fear and greed are harmful.  It takes a while to overcome those and trade with confidence
  • You take the time to practice.  That means using a paper-trading account with fake money.  But to gain useful experience, you must  believe it is real money and trade accordingly
  • If you don't have to win right now, you need the time/patience to learn.  I don't know if a few months are enough.  That depends on you

Technical Indicaors

No.  I have NEVER used technical indicators. I know that some traders are very skilled in doing just that.  But they do not learn overnight, and anyone who tells you it's easy to learn is not telling the truth.

I use no trading software, other than risk management software supplied by my broker.

 

I suggest getting started by reading or atteding some free seminars.  If you like what you read and hear, if you understand what you see, then go for it.  Plan to spend some time in the education mode.  Especially if you set a few months as the time limit.  There's no time to waste.  I wish you good trading.

846

Ebbets_Field_Outside2

 

 

, ,

16 Responses to Trader’s Mindset Series I. How Much can I Earn when Trading Options?

  1. Robert Schaude 12/03/2010 at 7:16 AM #

    Mark,
    First and foremost I want to wish you a very Merry Christmas. I also wish to thank you for your gift to us of the Options for Rookies website. It’s helped me learn alot, along with your O.F.R book. Especially the “lose the pride, take the loss early” lessons.
    I would like to ask you to consider a segment in the future that would talk about your thought process in choosing your trades. If possible, I’m curious how you choose your spread widths, lot size, and strikes and what products you trade in overall. I’ve noticed before your protocol of striving for a $3.00 premium for IC’s. Is that a one-lot price or the total value for numerous contracts? I currently do only paper trading in Paper Money on Think or Swim (6 months now in verticals and IC’s)and I see a lot of loss-risk vs. reward on the p/l graph when I try to reach those levels.
    I thank you for any help in this area and again wish you and yours the best.
    Bob

  2. Mark Wolfinger 12/03/2010 at 7:57 AM #

    Bob,
    Thanks or the good wishes. I’m enjoying a very happy Chanukkah right now.
    The $3.00 is a one-lot price. I find it much easier to follow discussions when trades are broken down into the lowest common denominator, and so that’s the way I write.
    Your request is a good one, but my technique is pretty simple. Don’t know how interesting it will be, but I’ll go for it – probably next Monday.
    Regards and thanks

  3. Frank 12/03/2010 at 11:51 AM #

    Hi Mark, enjoy your website and insights into option trading.
    My questions related to using delta to make adjustments to iron condors.
    I have trading iron condors for six months. From learning on experience I only trade spy, buying out two or three months out with a 4 point spread between long and short, will put on half a postion (50 to 100 contrats per leg) then expand position later depending on circumstances. When expanding the position I usually trade a three point spread and then perhaps shorten the spread on the initial spread. I select the initial short spread at a delta of .20 to .25.
    To make adjustments is delta a good metric to guide this choice if so at what delta .4,.5 etc if not any other metric you might suggest.
    Target to make 1.10 to 1.25 credit on initial position then add/adjust to either continue receiving a credit or tighten spread without additional cost.
    Thank you
    Frank

  4. Mark Wolfinger 12/03/2010 at 12:49 PM #

    Thanks Frank,
    I assume when you say delta of 20 to 25, you are referring to the delta of the options sold.
    Yes, delta is an excellent metric for making adjustments. You can use the number of deltas for your entire position and then adjust by buying back half to all of those deltas.
    However, I don’t believe that’s what you are talking about. You are referring to the delta of your short option.
    Frank – there is no good advice here because much depends on how much risk you are willing to take before becoming uncomfortable.
    My recommendation is that waiting until delta is 50 is out of the question. I used to do similar, but found it unrewarding.
    My suggestion (if you begin with delta as high as 20-25) is to make your first adjustment when delta reaches 35. You must decide how much to adjust, but 20 to 30% of your position is reasonable.
    Next, if delta reaches 40, I’d do more – keeping no more than half of the original position unadjusted. After that, I have no advice. Exit when loss is too high or comfort zone is breached.
    I have one very strong opinion: You may disagree, but you will eventually change your mindt.
    Making adjustments by continuing to collect additional credit is a very dangerous path. It requires that you keep selling extra spreads when you cover some spreads – and that increases overall risk. If you don’t sell extras, then it requires you to roll the trade to a position that is not one of your choosing – it is one forced upon you because of the cash you can collect. You are new to this game. Please consider this advice very carefully.
    It’s okay to spend part of the initial credit to make the position safer. It’s okay to exit the trade and take a loss. Trying to maintain the credit can lead you to holding huge, risky positions.
    I do not see how you can tighten the spread without additional cost unless you sell extra spreads.
    Fifty to 100 spreads that are 4 points wide is very big size for a newcomer. Are you truly comfortable with that much money at risk?
    Regards

  5. Frank 12/03/2010 at 6:36 PM #

    Mark, thank you for insightful reply.
    Yes, I am refering to the delta of the option sold.
    I understand your comment on continuing to collect credit to make a position safer and will reflect on choices to manage that situation. At the moment I try to leave open some long term open calls such as dec 11 to roll position if necessary. On occasion I will also buy a vertical spread with the long call bought in front of the initial short call.
    I arrived at 4 point spreads after trying front month condors with two or three point spreads but when making adjustments in response to market changes would result in low overall trade profit. Found 4 point spread a couple month out provides a reasonable beginning credit $1+ to make subsequent adjustments.
    Thanks again and appreciate and look forward to continue following your blog.

  6. Mark Wolfinger 12/03/2010 at 7:39 PM #

    Hello Frank,
    You seem to have things under control.
    I was not questioning using 4 point spreads. Just commenting that you are trading a bunch of contracts and hope you see both risk and reward potential.
    Good trading

  7. Alec 12/04/2010 at 11:51 PM #

    Hey Mark,
    Lately I’ve been tinkering with some software called “Options Oracle” (not sure if you’ve heard of it). Very useful for analyzing positions and working out what-if’s and dynamically charting various situations to do with effects on p&l of time, price movement and volatility, for instance. It’s totally free (which is surprising considering how powerful it is). Especially useful I think for the new guys who might not even have access to a brokers platform let alone anything more advanced. It can be a bit overwhelming at first but has some great documentation to go with it.
    Regards,
    Alec

  8. Jesse 12/05/2010 at 4:28 AM #

    Hi Mark,
    Larry Shover said in his book “Trading Options in Turbulent Markets”: “….contrary to what is frequently written and said about it, delta is not the probability that the option will expire in the money.” One of his arguments is that the probability measure that was used yesterday to predict today’s stock value no longer applies as the trader now is in need of a new probability for predicting tomorrow’s price.
    What’s your view about this?
    Thanks.

  9. Mark Wolfinger 12/05/2010 at 9:45 AM #

    Hi Alec,
    I’ve heard of Option’s Oracle.
    If you find the information it provides helpful, that’s the bottom line. I’ve included a link for anyone else who wants to give it a look-see.
    Thanks for sharing.

  10. Mark Wolfinger 12/05/2010 at 9:51 AM #

    Hello Jesse,
    If you are quoting correctly, he is correct and incorrect.
    True: Yesterday’s delta, or yesterday’s probability, is no longer valid. But did anyone ever suggest that it was still valid? Yesterday’s probability was yesterday’s probability and cannot possibly be today’s probability. I would have hoped that this was obvious to everyone.
    If we sold a 10 delta call yesterday, and today the stock moved so that the option is ITM, no one would suggest that there is a 90% chance that the option will expire worthless.
    I hope that he used his discussion as a way to CLARIFY possible misconceptions, rather than as a lesson to disprove the idea that delta represents A REASONABLE APPROXIMATION of the chances that an option will finish ITM when the market closes for trading at expiration.
    My view is: Clarification is good. So for anyone who believed that the initial probability held for all time, he makes it clear that probability changes every time the stock price changes or time passes.

  11. Noam A 12/05/2010 at 10:29 AM #

    Hi Mark,
    First i want to thank you that you share your ideas and willing to tech us the secrets of the options trading.
    I want to apologize for my English, i’m from Israel and my English is not my first language.
    I being trade in the israeli market for 3 years and the more the time past i’m falling in love in the options trading. i’m trying to master the butterflies. i know you like IC much more, but i feel with them very comfortable.
    I’m looking always for protections for my butterflies and though maybe the kite spread could help me.
    I hope this is to place to ask some questions regarding the kite spread:
    1)assume XYZ at 1000, and i buy 1 call 1050 and sell 3 call spreads 1070 /1080 – is there a way to understand from the greeks if the protection is good enough? you recommend to check it with thee P/L graph but maybe you can elaborate a little bit about the greeks?
    2) i’m thinking to manage each trade alone , meaning the butterfly to manage as it was all alone and so the kite spread.
    i’m trying to figure how to adjust it when it got some profit (if sell the long 1050 and buy the 1060 – i will increase my risk at 1080…) is there a way to lock some profit?
    and if XYZ decline? can i rearrange it to be in better position?
    I hope i’m not bothering you with all these questions, and you manage to understand them,
    Thanks again,
    Happy Hanuca
    Noam.

  12. Mark Wolfinger 12/05/2010 at 11:05 AM #

    Hello Noam,
    I am not sharing ‘secrets.’ Just trying to pass along useful information.
    I am pleased that you sent these questions – and yes I understand them. This is the right place to ask questions.
    I’m glad you are trading butterflys – a position that makes you comfortable. That is very important.
    1) The Greeks are useful. The position you mention would have positive delta and positive gamma. It also has negative theta. However, the Greeks give you a temporary picture of ‘protection.’ That protection changes daily and it changes as XYZ moves higher and lower.
    Please be aware of this: Kites look good. But, if you own them until expiration day, they become very risky. Why? Because that 1070/1080 spread may move from worthless to losing $3,000 overnight. This risk is NOT present when more time remains in the lifetime of the options.
    You can ‘see’ this specific risk by using graphs.
    If XYZ rises and moves near 1070, then you would have negative gamma – for a limited time. If XYZ continued to rise, near 1080 you would once again gain positive gamma.
    2) Managing the kite spread – as a separate – position is a good idea. It may be the best way to handle kite spreads.
    3) In my opinion, the best way to adjust is doing as you said: To sell the 1050 and buy the 1060. Yes, it does give you the chance to lose money at 1080 – but that loss would be small.
    I do not see any way to lock in a profit with the ‘regular’ kite spread that you chose.
    That is the reason why it is important to collect a big cash credit when selling the 1050/1060 spread. If you collect $650, then you most you can lose at 1080 is only increased by $350. To me, that small loss is worth the risk. It gives you a chance to take some cash out of the kite spread.
    But if you sell that spread for $400, then I don’t like that. Taking $400 cash out of the position and increasing the possible loss by $600 is not a good idea.
    4) If XYZ declines, there is not much you can do. The cash you paid to own the kite spread is at risk. If you try to recover some of that cash, it will increase upside risk.
    Of course, you can always sell the kite spread and that will probably result in a small loss – depending on how much time has passed.
    I don’t worry about this kind of loss because: You opened the kite to protect the butterfly. If the market moves lower, then the butterfly should be doing better. This is a situation in which you paid for insurance, but it turns out that it was not necessary. That is not bad. It’s good that you traded to reduce risk. Many times that adds some extra profit to the trade. But, it often turns out that insurance costs money.
    In my opinion, buying protection is good. But the major reason for buying it – is to gain protection and reduce possible losses. That’s the important part. The secondary reason to buy protection is to earn extra profit. That is far less important and if you lose some money, you did have insurance when you needed it.
    Regards and good holidays to you.

  13. Noam A 12/06/2010 at 1:55 AM #

    Hi Mark,
    Thanks for the quick and detailed response.
    I have some additional questions regarding the kite spread I will happy to hear your thoughts.
    1) Greeks: my concern is to “over protect” my main position with the kites. for example the negative theta will cancel my other positive theta from the main position.
    Maybe you have some kind of thumb rule ,regarding the Greeks to know if the protection is actually effective for example theta ratio or maybe the percentage from the capital to allocate for insurance?
    2) Adjustment: I play a little bit with the kite yesterday and realized 2 main things:
    a. The cost of the trade is the maximum lost in both lost ranges (in my example XYZ<1050 and XYZ = 1080)
    b. The kite spread is actually equal to non balanced butterfly with extra call (or put for down side). In our example the 1 long call 1050 and 3 short spreads 1070 1080 is actually a “butterfly” 1 1050/-3 1070/ 2 1080 plus extra call 1080.
    I thought about 2 ways of adjustments in case of XYZ going up:
    1) Remove 1 1050/-3 1070/ 2 1080 and remain with 1 long call 1080, with no lose.
    2) Roll the single call 1 strike up AND remove 1 short spread. I mean 1 short 1050 1 long 1060 and 1 long 1070 1 short 1080. This adjustment will result a smaller “butterfly” : 1 1060/ -2 1070/ 1 1080 plus additional long call 1080. Is it possible to make this adjustment in a premium that at least equal to the cost of the kite? I don’t know, but I think it can be and then you result a spread with no risk.
    In a case of downside, what do you think about selling fat OTM call to receive some premium?
    I 100% agree with your perception that insurance is insurance and suppose (in the begin at least) to cost money. But if I will manage it by itself, I think I could eliminate the risk and gain more in a case of big move. What do you think?
    Again, Thanks a lot for everything,
    Noam

  14. Mark Wolfinger 12/06/2010 at 8:46 AM #

    Noam,
    1) No. I do not.
    The best suggestion is examine the risk graph of the position you want to build – and change the date. These kite spreads break down near expiration (by that I mean risk gets very large) whenever the underlying is near the short option of the spread portion of the kite. Gamma gets very high.
    Kites are not designed to be held through expiration.
    I use them to protect other trades – and suggest exiting the whole position weeks prior to expiration.
    If you hold your trades longer than that, then the kite is not the best protection for you.
    2) Closing the unbalanced butterfly portion of the trade is a good way to get your cost out. But it leaves you long an extra 1080 call – and you must decide if that is the option you want to own as protection.
    In fact, if that is your thought, it may be easier to just buy the 1080 call in the first place.
    a) Any adjustment is acceptable
    b) I often roll up the long call in the kite spread and use the cash to buy back some of my short spreads. Of course, you cannot buy very many (you buy only one in your example), but this is one way to reduce position size and original cost.
    Whether you can make the adjustment for the ‘cost of the kite’ depends on when you bought the kite and what you paid for it. If you bought it when it was far out of the money, then perhaps you may be able to meet this goal. I sometimes pay more than $1,000 for a kite, and thus, can never recover the cost by doing as you suggest. It just depends on the prices paid. I would NOT expect to be able to do this very often, if ever.
    3) Selling fat OTM call is fine – if you are willing to give up the upside potential. I like this idea – as long as you collect some cash (i.e., 50 cents is not good enough) and the rest of your portfolio does not need upside protection.
    4) Good risk management and good trading skills will always help the trader succeed. If you can trade your insurance to eliminate risk, consider using those skills to take profits out of other trades.
    Shalom

  15. Noam A 12/06/2010 at 9:03 AM #

    Thanks again!
    I will play with it a little bit.
    Toda Raba (-:
    Noam.

Trackbacks/Pingbacks

  1. Profit Targets | Options for Rookies Premium - 06/05/2013

    […] Brand new option traders almost always ask: “How much money can I earn?” That is a bad question for many reasons. […]