Well I know barely enough about complex options positions to know you are correct. A little knowledge is dangerous, so I keep to my self-imposed rule of no complex options positions. No straddles, strangles, reverse straddles, naked spreads, reverse cowgirls, naked doggie straddles….wait, I think I’m mixing up complex options and sex positions. It is so confusing!
I do own a hardcover of the recognized Bible of options analysis, Options As a Strategic Investment by McMillan.
I’ve never read beyond page 10.
Ahhh, but it looks impressive on the shelf in the study! Some day it could come in handy. I could defend the home by using it to pummel any home intruder. It weighs about three pounds.
Here are my rules to make money (or at least minimize losses) when trading simple option positions (long calls, long puts):
1) NEVER EVER hold more than 5% of your total retirement portfolio in aggregate option positions (direct or indirect). Better yet, self-police by putting 5% (or less!) of your portfolio into the only account where you’re granted LEVEL 2 options trading.
COROLLARY: if you’re just starting, spend a few years limiting yourself to a few hundred dollars in total options positions, or whatever to you is “pocket change” that you can afford to lose.
2) Estimate the date when whatever expected economic event will turn your options into gold. Now DOUBLE or TRIPLE that time frame in choosing your expiration date.
Invariably, optimism that your market theory is correct will have you imagining it hitting markets far sooner than actual = markets can stay irrational longer than you can stay solvent, especially if your exp dates are too near!
2a) Decide the MAX amount of chips you’ll bet on outcome of a particular market theory. Now, only use about 25% (or less) of that money pool as you take the first option positions.
Then wait, and watch, at least a few months.
Bet the remainder of your reserve chips only if market heads where you expect. Even if things go perfectly don’t bet more than the limit of chips you set before entering the game.
3) Never go for “sucker bet” out-of-money (often near-term) strikes that tease you with their incredible 5X, 10X, or similar fantastic apparent leverage
Before buying, always run a comprehensive options spreadsheet simulation, plotting %ROIC (% Return on Invested Capital) vs. strike price “break-even” curves for various expirations dates, all for a specific option type on specific security. These graphs will expose the “sucker bets” that offer great leverage but require ridiculous volatility in short period to be “in the money.”
I often spend hours running those simulations to identify the optimal option that breaks even after only a few percentage points change in the underlying security, AND also takes advantage of a market inflection point I’m certain is coming, but others haven’t priced in.
That’s the key.
The optimal strike and exp date will often cost you $3000, $5000, or more to get 10 contracts. You gotta pay for quality. Ignore the $0.50 priced “sucker bet” contracts!
4) Options are like Big Guns. You keep them in the closet. You only take them out for rare occasions, when Something Big is coming and you see it clearly.
5) Other helpful rules others want to post?
(I’m still learning.)
