You have learned different aspects in regard to all the factors that go into making a good options trade, it’s time to start putting your new knowledge into action. This is a two-part process, the first part of which is coming up with the right plan and the second is executing that plan in the right way.
Work out a plan
Before you can begin trading successfully, the first thing you are going to need to consider is creating your own personalized trading plan. This plan will include several facets that are unique to you and proceeding without taking the time to create your own plan is a good way to kill your options trading career before it starts.
Start by considering your skills: When it comes to ensuring you have the right options trading plan, the first thing you are going to want to do is take a look at your overall skill level and familiarity with trading in general, if not options trading specifically. Many new options traders are tempted to overestimate their skills early on, but this will do nothing but hold you back in the long run. Be honest and accurately catalog your strengths and weaknesses. Specifically, you want to have a clear idea of how likely you are going to ignore your plan in favor of following your emotions. This is always a folly and if you know it is your tendency you are going to have to plan around it.
Think about other challenges: When it comes to determining what plan or system works for you, it will be important to take into account any other potential challenges that you might need to face in order to achieve the level of success that you are hoping for. These types of challenges could be anything from a lack of resources or planning to something more complicated and personal. The point is, anything outside of the normal market inconsistencies that prevent options trading from being purely profitable should be accounted for to ensure your success rate remains as high as possible.
Consider the right amount of risk for you: When it comes to deciding how much risk is the right amount for you, the first thing you are going to want to do is decide how much your total investment budget is going to be. If you have never invested anything before then this investment budget can be seen as your portfolio. Never put more than 5%of your total into any one trade which makes it difficult to lose anything too substantial all at once. What’s more, you are going to want to determine if the trade is worth the effort by ensuring it is going to pay off at least 300% when compared with the initial investment.
This is what is known as the risk/reward ratio and it can be found when it comes to any options trade by simply taking the amount of estimated profit and dividing it by the amount of the investment. If the result is greater than or equal to 3 the trade will be worth your time if it pays out. Remember, the return will only happen if the trade works in your favor, however, which can be determined by finding your own level of tolerance when it comes to investment risk.
Finding your own tolerance level when it comes to risk can be accomplished by taking the amount of time you have available to work on investing versus the amount of potential returns you are looking for. This means that the less time you are willing to spend on investing in options, the more risk you are going to have to be willing to accept if you are hoping to make more than a moderate amount of money from doing so.
Do your homework: Each and every day in the hours before the market opens you need to plan on being in front of some type of screen, learning about everything that happened while you were sleeping and deciding how you think it is going to affect the markets you are interested in the most. This means checking foreign markets, the premarket forecast and the index futures to name a few, all in the name of deciding what the market’s mood of the day is going to be after the day gets going properly and trading actually begins.
You will also want always to be aware of any upcoming due dates for earning data to be reported which will always disrupt the market in question in one way or another. Companies have to report their earnings in comparison to their projections 4 times a year and the results are almost always going to affect the market in a serious way. The right choice in these instances is to wait until the rash of panic trading has passed and get in once things begin to stabilize but not so much so that there is no longer a profit to be made by doing so.
Decide on an exit strategy: No matter what plan or strategy you settle on, it is important to have a clear idea of what an acceptable level of profit or loss means to you and setting a firm exit strategy accordingly. While it can be tempting to wait on an underlying stock to rebound before exercise your option or walking away, the results are rarely going to end in your favor and it can lead to a bad habit of hanging on to sub-par trades that could possibly cost you big in the long term. The right exit strategy for you will vary based on how much risk you can accept, coupled with how many trades you are planning to make each day and what level of micromanaging you are comfortable with. Regardless, the point at which you decide to bail on a bad trade should be the same for all of your trades.
Setting up an effective exit strategy begins by deciding where the appropriate point to set what is known as a stop loss is. A stop loss is an automated order that you put in when you purchase the option which indicates at what point you want the option to be sold automatically. It is used to minimize your losses if a trade suddenly starts heading in the opposite direction you were hoping it would. You should avoid setting stop losses on options with extremely volatile because they are likely going to fluctuate too much to make them truly effective in this instance.
Stop orders are useful if you are the writer as well as the holder because they can be used to ensure that additional options are purchased if the price rises instead. You will also sometimes find it useful to use a secondary stop order which will sell if the price then hits a secondary amount. This is considered the price target and it is the amount that you can most expect to make on the trade in question. When you hit a price target you are going to want to sell off half of your total holdings and move the first stop point up to this point. This maximizes both your profit potential as well as minimizes your total risk.
For example, if you have a pair of options totaling 200 shares of a stock that is worth $20 to start. You would set a stop loss at $19.75 to prevent yourself from losing much money. If the stock then hits your price target of $30, then the best course of action is to sell 100 shares to ensure you see some profit from your price target before holding on to the remaining shares and setting a new stop loss of $30. This way you are guaranteed to see the profits of your previous price target while at the same time leaving yourself open for additional profits assuming the positive trend in the underlying stock continues.
Find a point of entry: Once you know when you are going to want to get while the getting is good, you will next want to determine when you are generally going to want to jump in on a profitable option trade. Start by considering your acceptable risk and then decide what you want to do when you find an option that falls within your risk level. The most common entry decision is to buy a single option. Depending on your level of risk, you are also going to want to consider secondary factors, as you want your entry point to be discerning enough to weed out lousy propositions but no so stringent that the good ones also fail to get through. It will get easier to find the perfect entry point, the more practice you obtain at trading options.
Ask yourself about your goals: When it comes to creating the type of trading system that is right for you, it is important to have a clear idea of just what you hope to accomplish when it comes to long term trading so you then have a better idea of how each individual trade can help you come one small step closer to your goals. You want to keep any limiting factors in mind when it comes to determining your goals, but you also want to keep your goals realistic as well as what is known as SMART.
S: The best goals are specific in that they make it clear why you want to reach the goal in question as which requirements stand in the way of your success. It will also make it clear when the goal is likely to be completed, where the completion will take place and who besides yourself you are going to need to call upon to complete it successfully. Specific goals are important because they are far more likely to be completed than those that are general.
M: The best goals are measurable which means they have several points that can provide distinct feedback as to the overall success or failure of the goal as a whole. If you clearly know when you have reached a new milestone, then your goal is measurable.
A: The best goals are attainable when all of your unique challenges are taken into account. No matter your intentions, a goal that is unattainable is never a good goal.
R: The best goals are realistic, which means that not only are they attainable, they can be completed based on the amount of time and effort you are going to be able to put forth on average.
Timely: The best goals are those which have a specific, but reasonable, timetable for completion. Goals that are too strict when it comes to a timetable will never come to fruition in time; meanwhile, goals that are too vague when it comes to a timetable will also never see success because it is too easy to put them off indefinitely. Keenly track your progress: If you are new to options trading, you will likely find it useful to keep extremely precise notes when it comes to the trades you made, the mental state you were in when you made them, and the ultimate outcome of each. Keep track of the metrics throughout your day, every day, but to also to avoid pouring over them at the end of each day with the goal of passing judgment on your system. A good system needs at least a few weeks to determine if it is at all worthwhile, and then another 2 weeks if its results are near 50 percent or better. Nothing is gained by looking for results where there are none that are strong enough to be accurate seen. Be patient and the information you have to analyze will be much more useful.