If you trade options and are struggling to find consistency or profitability it’s likely because you are breaking, knowingly or unknowingly, some important rules. Rules that are designed to keep you safe, protect your portfolio, and cater to the math and probabilities that drive any options selling system. On this episode, I’ll walk thru the 11 common options strategy mistakes you might be making right now. Plus, we’ll talk about the core principle or rule associated with each of the mistakes, which will help you quickly correct your trading system and ultimately find success sooner.
Key Points from Today’s Show:
1. Position Size
- Position size is absolutely the biggest mistake traders make, in that their position size is too large.
- The only thing that really kills you long-term is sequencing risk (see Show 139).
- Correct position sizing counteracts the sequencing risk long-term.
- Position size should not exceed 5% of your overall trading account.
2. Low Trade Count
- Traders make the assumption that the win percentage is always true for every trade.
- However, trading is a probabilities game.
- You need to trade long-term so that your trade count more accurately reflects the expected outcome.
- Win rates really only start to solidify over the long-term, making hundreds of trades.
3. Diversity of Tickers
- Having a diversity of tickers that you are trading is key.
- The risk in trading one ticker is that you have a ton of risk if that one ticker becomes unstable and volatile.
- You should at least have 10 to 15 tickers every single month (see Show 143).
- Diversity in tickers gives you the flexibility to have a losing trade without blowing up your whole portfolio.
4. Portfolio Balance
- You cannot be a one-sided trader; it’s just too risky.
- If you are going to be trading options, you need to do so on a portfolio-neutral basis.
- Having a neutral portfolio is what the largest institutions do on an on-going basis.
- You should be overall neutral to a lot of the market movements so that one massive move in one direction or another does not hurt you.
5. Option Buying Versus Selling
- Option buying just does not work as a long-term income strategy.
- As option buyers, you end up paying the implied volatility premium.
- You have to be more of an option seller than an option buyer.
6. Using the Stop-Loss Order.
- Stop-loss orders create more losing trades (see Show 67).
- Backtested strategies prove that using stop-losses in multiple environments and multiple situations create more losing trades.
- Using stop-losses as a core strategy is not good for your portfolio.
- The better alternative is to position-size better.
7. Not Exiting Positions Early
- In many respects, exiting early ends up increasing our win rates, and ends up reducing the time that we’re in the trade.
- Not exiting early reduces drawdowns, it allows us to more quickly recycle capital in our account.
- Using these exit targets is a very viable strategy across the board for increasing returns.
8. Total Account Allocation is Too High
- No one ticker symbol should represent more than 5% of your total account.
- Someone around 30% of your account tends to be one of the more optimal allocation zones.
- This means that on an on-going basis, 70% of your account should sit in cash as a cushion.
- Options trading is highly leveraged, so when you win, you win massive returns on an options strategy on a small portion of your account, which more than makes up for the amount of cash that you have sitting in your account.
- However, if you over-allocate and a bad string of trades come along, you get wiped out immediately.
9. Reducing Commissions
- Negotiate with your broker and move to a platform that has lower commissions.
- Most brokers are moving towards a commission-fee platform.
- Use these platforms to your advantage to negotiate better commissions or reduce the commissions you are already paying.
- Reduce the fees as associated with your return.
10. Adjusting to Reduced Risk
- The mistake that traders are making is that they are adjusting to increase profit potential, which is not what you should e doing.
- Need to try and curb the loss that you have in the position.
- A lot of traders give up at expiration, which is probably the worst thing you could do.
- If you could take a trade that should lose $700 and cut the risk down to $300, so you can lose less, this creates a winning trading strategy.
- Take the losing trades and adjust them down in risk by rolling, adjusting, moving sides closer, and adding positions, etc.
- This creates a winning strategy because you can cut the risk.
11. Fighting Back
- Fighting back against the market is just an emotional thing that people do.
- The sooner you realize that you have no control over the market and anything can happen at any time, the better off you’re going to be.
- So stop pushing back against the market, and welcome the volatility and unexpectedness as your friend.
- Most of trading is the 80/20 rule; 80% of what you do is just psychological, and getting through the mental barriers that you have put up in your mind.
Free Options Trading Courses:
- Options Basics [20 Videos]: Whether you’re a completely new trader or an experienced trader, you’ll still need to master the basics. The goal of this section is to help lay the groundwork for your education with some simple, yet important lessons surrounding options.
- Finding & Placing Trades [26 Videos]: Successful options trading is 100% dependent on your ability to find and enter trades that give you an “edge” in the market. This module helps teach you how to scan properly for and select the best strategies to execute smarter option trades each day.
- Pricing & Volatility [12 Videos]: This module includes lessons on mastering implied volatility and premium pricing for specific strategies. We’ll also look at IV relativeness and percentiles which help you determine the best strategy to use for each and every possible market setup.
- Neutral Options Strategies [7 Videos]: The beauty of options is that you can trade the market within a neutral range either up or down. You’ll learn to love sideways and range bound markets because of the opportunity to build non-directional strategies that profit if the stock goes up, down or nowhere at all.
- Bullish Options Strategies [12 Videos]: Naturally everyone wants to make money when the market is heading higher. In this module, we’ll show you how to create specific strategies that profit from up trending markets including low IV strategies like calendars, diagonals, covered calls and direction debit spreads.
- Options Expiration & Assignment [11 Videos]: Our goal is to make sure you understand the logistics of how each process works and the parties involved. If you don’t feel confident in the expiration processes or have questions that you just can’t seem to get answered, then this section will help you.
- Portfolio Management [16 Videos]: When I say “portfolio management” some people automatically assume you need a Masters from MIT to understand the concept and strategies – that is NOT the case. And in this module, you’ll see why managing your risk trading options is actually quite simple.
- Trade Adjustments/Hedges [15 Videos]: In this popular module, we’ll give you concrete examples of how you can hedge different options strategies to both reduce potential losses and give yourself an opportunity to profit if things turn around. Plus, we’ll help you create an alert system to save time and make it more automatic.
- Professional Trading [14 Videos]: Honestly, this module isn’t just for professional traders; it’s for anyone who wants to have eventually options replace some (or all) of their monthly income. Because the reality is that mindset is everything if you truly want to earn a living trading options.
Option Trader Q&A w/ Allen
Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. This episode’s question comes from Allen, who asks:
My question relates to whether or not you benchmark the expected return against the risk for credit spread trades and if so, what is your methodology? I was thinking of employing the following methodology for credit spreads: the probability of profit, multiplied by the amount of the credit, divided by the probability of loss, multiplied by the max loss. Do you think that’s an appropriate methodology and if so, what is the line in the sand hurdle rate for you if using that methodology?
Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.
PDF Guides & Checklists:
- The Ultimate Options Strategy Guide [90 Pages]: Our most popular PDF workbook with detailed options strategy pages categorized by market direction. Read the whole guide in less than 15 mins and have it forever to reference.
- Earnings Trading Guide [33 Pages]: The ultimate guide to earnings trades including the top things to look for when playing these one-day volatility events, expected move calculations, best strategies to use, adjustments, etc.
- Implied Volatility (IV) Percentile Rank [3 Pages]: A cool, simple visual tool to help you understand how we should be trading based on the current IV rank of any particular stock and the best strategies for each blocked section of IV.
- Guide to Trade Size & Allocation [8 Pages]: Helping you figure out exactly how to calculate new position size as well as how much you should be allocating to your each position based on your overall portfolio balance.
- When to Exit/Manage Trades [7 Pages]: Broken down by option strategy we’ll give you concrete guidelines on the best exit points and prices for each trade type to maximize your win rate and profits long-term.
- 7-Step Trade Entry Checklist [10 Pages]: Our top 7 things you should be double-checking before you enter your next trading. This quick checklist will help keep you out of harms way by making sure you make smarter entries.
Real-Money, LIVE Trading:
- EWZ Iron Butterfly (Closing Trade): After nearly pinning the stock at our short strikes, and thanks to the volatility drop, we netted a $600 profit on this iron butterfly trade.
- VXX Short Call (Closing Trade): One of the most consistent and profitable options trades we can make is shorting pure volatility with VXX and today we closed this naked short call in VXX after a couple days for a $420 profit.
- DIA Iron Condor (Adjusting Trade): This neutral iron condor in DIA is need of a quick adjustment early this week as the market continues to rally. In this video, we’ll discuss why I’m adding an additional put credit spread while also choosing NOT to close out of our current put credit spread due to pricing reasons.
- COP Short Put (Closing Trade): These single short puts in COP acted as a great hedge for our other bearish bets in oil this month and helped smooth out our returns after we closed them for a nice big profit.
- TSLA Put Debit Spread (Closing Trade): Although many people thought we were crazy for getting bearish in TSLA this pre-earnings put debit spread trade made us $200 today. After the huge run up from $140 to $260 and getting some technical sell signals, we were pretty sure this stock would pull back.
- MON Iron Condor (Closing Trade): Following a huge drop in implied volatility we worked hard to close this MON iron condor trade adjusting the order multiple times to fill before the end of the day.
- IBB Call Debit Spread (Opening Trade): We’ll show you how I started searching for a new bullish trade and eventually found a low volatility trade in IBB looking for a move higher to hedge our portfolio.
- TLT Iron Butterfly (Closing Trade): Following the Brexit vote TLT and bonds traded in a nearly $8 range really quickly – even still the drop in implied volatility helped generate a $330 profit for us.
- XBI Call Debit Spread (Closing Trade): Got lucky picking the exact bottom for our entry in this call debit spread for the XBI biotech ETF which ultimately was closed for a profit of $165 today on the rally higher.
- COH Iron Butterfly (Earnings Trade): Shortly after the market open we close out of our COH earnings trade for about a $160 profit, leaving just 1 leg on to expire worthless.
- EWW Debit Spread (Closing Trade): Using some of the technical analysis signals we discovered in our backtesting research, we were able to make a quick $130 profit on this bearish EWW debit spread trade.
- IBM Iron Condor (Earnings Trade): Shortly after the market opened you’ll follow along with me as we watch volatility drop and liquidity come into the market before closing out the position for $250 profit.
- SLV Short Straddle (Opening Trade): Using our watch list software we decided to continue to add to our existing SLV short straddle position with a new set of strike prices reflective of the move lower in the ETF recently.
Thank You for Listening!
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