Directional Trading

A thought entered my mind today. Since it was one of only two, I figured I ought to write about it.

This blog is a watering hole for various option traders from all walks of the earth. We all have one thing in common and that is that we trade options. As I read what is spoken here we all have different experiences with success, failure, profits, losses, etc. It makes me realize that even though we may trade the same underlying stocks sometimes, that the outcome is a totally different experience depending on your set of entry and exit rules. I have talked about the topic of entry and especially exits more times than I can remember, but today I want to talk about the underlying strategy. Are you certain you want to be an option buyer?

You are all here learning to trade options, but is this where you really wanted to be? Why is it as traders you wanted to trade options? Leverage? Why not futures or currencies? Was it the correlation to stocks? Do you feel you know the market better than the economy or macro economics? Why trade options?

I have gone full circle in my career. Stocks, options, currencies, futures, and back to options. I like to trade options because they are multi dimensional. There are various ways to profit. For those who don't understand the various dimensions, I hope you realize that whether you profit or not goes beyond the stock price going up or down. You can have a stock move in favor but lose on the option. If you didn't realize this, read my archives, or drive slow.

Since there has been an underlying tone about success, failure, quitting, working harder, etc I want to do my part to talk everyone through the reality of being an option buyer. Most importantly I want everyone to realize that just because I have found success in the way that I trade, this does not mean that it is a strategy that will work well for everyone. I am not trying to navigate you away from your approach, I only want to insure that you understand the odds, nuances, and details of this type of strategy.

First off, did you know the odds of success as an option buyer are totally against you? Imagine an option contract for just a moment. Who has the higher probability of success? The buyer or the seller? Since options are a time/expiration based product, they decay in value. Based on this factor, you have a higher probability of success being a seller. A comment surfaced recently about the success of our student base, and for anyone that has attended a trading room or talk product and filled out the annoying poll, you can see that we actively track our students success. What the results say is that our students are finding more profits trading spreads vs. directional trading.

Not only do options melt, but you pay a premium for melting time. This premium fluctuates and not everyone understands fully how to make it work for you. With changes in time and fluctuating premium, this puts more pressure on the price of the stock to move in your favor. With a typical individuals irrational thought process and timing inefficiencies, this becomes a very low probability of being right. This is why many option traders will tell you that options are meant to be sold. They do have a point. However, how many books have you read about market wizards, or any traders for that matter that made it to the top trading spreads? I can recall a lot of stories about blow ups, but this was for lack of risk management. Are you trying to make it to the top? Or do you just want to supplement your income?

Most of you know I am not a spread trader, but in truth I do not dismiss it altogether. In fact, I will do my part to discuss this strategy a little more openly through the blog. The biggest debate among options traders is which side of the trade you are on and I want to make sure everyone can say with conviction that they are on the right side of the trade.

In the end if this influences a strategy change, or at least a sense of urgency to explore and make sure that the type of activity you are soliciting is what you are good at, or fits well with your style, personality and investment objectives than I can say this was worth it. Matter of fact I just opened another e-mail addressing the same point. This post is timely in my opinion and do a little soul searching to make sure you are doing the right thing with you financial future.

Let me hear your thoughts. Also let's hear it for CME.

Recommendation: "life comes down to a few moments....this is one of them." Bud Fox; Wall Street

Long: Community

Short: CME

Great post, Jeff and your points should be well heeded. I would suggest to any relative newcomers that it takes over a year to learn how to trade and even another year to learn how to make money trading. Sometimes longer. Personally, i never paper traded. I took a beating and i'd love to have that money back but i can't say i'd be as far along as i am now if i didn't have the long nights, the shocks to my psyche, the self-doubt. It forces you to decide if this is REALLY for you or not. Time and again i have forced myself to rectify my mistakes (many i made over and over again). I tell myself that the difference between where I will be and where most other people will be is that i was willing to continually break myself down and put myself back together. For those of you who quit, I feel badly, since I don't wish any harm on anyone, especially option addicts. However, and I mean this respectfully, I am competitive and I am driven to succeed here. I truly love interacting with all of you and learning from each other. But at the end of the day, only a small number of us will be traders and I intend to take one of those spots.

PS CME is nice but so is BOT jeff.

Good action on CME about time. If the market trades down for the next few days which I'm leaning towards I'm sure CME will move closer to its price target of $510 or so.
Kicking my butt for selling my KBH put yesterday. Ohh well it did better than i expected.

Danny DR

Jeff:

I am not able to sit in front of the PC all day so I rely on stops and when my stops are hit I always feel like I am getting ripped off by the market maker. I like bear call spreads right now b/c they are easy to monitor and if I want to exit one I feel like I have more control. Of course if you don't control risk then these kill you quick.

Any body else bearish on MA? The fundamentals look bad and the price has been recently down trending below the moving average but that big mouth Kramer recently said to buy it so I wonder if that is why it is staying up while everything else falls. Any thoughts?

Hi Jeff,

I almost feel like your comments today were for me and perhaps a result of emails exchanged. The problem with spreads in my opinion is that you can have a lot of wins that don't earn much and then have a loss that wipes out all the wins because of the risk/reward ratio--even trading way OTM.
Regarding option trading, for me this is a learning curve. All the information is new and applying this new found knowledge with some acumen isn't going to happen overnight. Making mistakes is part of the process and it takes time for some of the concepts to sink in--at least for me. So as for me, I won't be dissuaded in this endeavor and am determined to figure it out and be successful even at the risk of looking inept most of the time.
So please hang in there with us because I intend to hang in there with you, your classes and your blog.
Suzanne

Howdie Jeff,

Your blog is awesome and full of helpful info. Keep up the great job!!!

Great post... the learning curve varies greatly from person to person. This blog is an awesome way to learn more "real life application" to what all the books, courses, etc theorize about

Justin

Hi Jeff,

Loving CME, but I also have puts on GOOG, LEND and NDE. Subprime is getting all of the attention. I don't believe this story has played out. Look for some of the stocks that still have room to move, such as IndyMac (NDE) and Countrywide (CFC).

I've been with Investools for a year and I've been combination paper trading and real trading. It was only recently that I started to recognize good entry and good exit points. Good entry points minimize your exposure to loss. To often, I was getting in near resistance and getting stopped out at support. The Advanced Technicals class really helped solidify my process and buy and sell signals.
I'm starting to feel, whichever way the market trades I am ready for it.

Thanks Jeff and all of the other instructors at Investools. There's no other way to get this type of knowledge with spending years of training and thousands in the market.

Joel R.
California

Jeff,

You know very well what our minds are thinking in situation like this. You're NOTE keeps us encouraged and hopeful. Pls. try to add them as and when you think its appropriate.

--thanks, Meena

Jeff and fellow bloggers,

Thank you for the great option community!

I feel I have to give an account of my short trading career in light of the mood that has been running amuck the community as of late.

I must say that I am feeling pretty damn lucky since I just started trading in November and feel real confident in what I am doing. My first month I lost money, but not much. My second, December, I almost made back as much as I lost in my first.

In January, I began doing the Matertalk Series, at least one per week with some weeks digging into the archives. Also in January, I began listening to the Marketcast each evening; I have only missed two nights since… I believe. In February, I found THE BLOG. I have printed all of the archived posts and have read them all more than once. Several times a day I visit the blog to see if anyone has posted any new comments.

I have attended the Investools Stocks and Basic Options courses and have read the course material for the Advanced Technical Analysis course several times.

I am thrilled to say that I am up over 30% since I began the Matertalks, the Marketcast and THE BLOG.

My wife says that she has never seen me so committed to something. I must admit, other than my addiction to skiing, mountain biking and hanging out with my wife and children, this is the first time I have committed myself to my education since I passed the CPA exam fourteen years ago! In this journey, I have found another addiction, trading options.

I have been an accountant by trade for the past seventeen years, accountants are supposed to be conservative, right? I have taken my thirst for extreme sports (trading directional options) and coupled it with the conservative nature of my job. I love this business and have a BEHAG of retiring from fulltime accounting in five years. All this would not be possible without this option community, the MT/MC combination and all they have to offer.

I continue to learn each and every day and continue to refine my trading rules (which are not written yet… shame on me). I have notes jotted down on paper in a file but I am very disciplined about documenting my entries and exits on the ProphetCharts of the equities that are on my watchlist and in my “we own” folder. If I have no notes or analysis on my entry and exit on an equity, I don’t participate. It is that simple.

For me the hardest part was eliminating emotion from both entries and exits. My main rule is that my risk reward must be 3:1 at a minimum and I won’t get emotional about entering a trade as long as I have that ratio. I also know from this risk/reward calculation when my trade has gone bad. A “gone bad” trade is a real unemotional time of exit. I set stops at 0% to 70% of the option price and have the liberty of watching intraday action nine out of ten days. Hitting my target is also a time to tighten up a stop using the ATR and a trailing stop or if I am enough above the original target to prevent being kicked out by intraday movement I prefer to use the target as my stop. I will then exit on weakness from candle pattern analysis or news. I try to enter and exit trades at the end of the day but sometimes have lunch meetings and have to use amateur hour the next morning.

I know rocky roads are ahead but we have an in-house therapy community here to see me through. I like to call it Kolher’s Couch… I find that I rarely have to post my thoughts and feelings because someone else is asking/feeling the same thoughts.

Right now CME looks like gold. I hope everyone had a chance and is participating.

Again, I feel real fortunate and lucky to be where I am right now and thank you all for lending a hand.

John
Rhododendron, Oregon

Jeff and all -
What I had to say has been said so only a big THANK YOU! from me.
Bob H.
CA

Brett,

I completely agree with your comments. This takes time and committment. I know I spent 4 years of college and 2 years of graduate school to start my first career. So what's a couple of years to learn and become a consistently profitable trader.

By the way I'll be joining you in one of spots.

Sarah

P.S. great post Jeff. I also had a great day with my SPY puts.

Jeff:
Your blog is beyond awesome. We want to trade like you!!

I believe that the probability of an option expiring worthless is about 75%. With that said, when I first started trading I only use to sell puts of the stocks I wanted to own. This strategy works best only in up trending and sideways market. I tried this for a year and I did well, the problem was that I kept on finding good stocks and the reward was small compared to buying the underlying stock. Certainly, when I was wrong I was really wrong and wiped out a lot of gains.

What a lot of people do not understand; that buying options, should be done with some type of technical knowledge of how fast, how much and how long will that option last until your price is met. If you lack that knowledge, or you feel that you rather direction trade, buy an option with a high delta, it is very similar to owning the stock and as long as the analysis of the direction is right you will profit. With this strategy you still spend less than owning(leverage) the stock and you have a determined risk.
Speaking for myself, I think if people heard more instructors talk about the losses that they experience and why they concluded to take that loss, they would feel better knowing that trading is not always about being right.

Everybody has loses, the trick is to lose less than you win.

I have recently spoke to a fund manager and portfolio manager. When I started telling them the strategies that we use and have learned, they could not grasp half of them and it surprised me that their only strategy is buying stocks.

I think we all get frustrated, because we want to trade like Jeff and all the pros at Investools, but we forget that all these traders have paid there dues to the market. The only difference is that they persisted and found a way to beat the market.

Just know that if you went to open a business, the success ratio for that business to be profitable is minute. This is the same thing, you opened a business and it may fail, but if you persist and cap your losses, who knows you could be the next McDonalds or the next Jeff!!.

We all new the possibilities of the market re testing the lows, some of us went long and some of us took the advice from Jeff to nibble if you were not sure.

Keep it up, once we figure out a system that works, and one that limits our losses we will know how to react to trades going against us. This is a business that we have to keep on adapting to and keep on learning.

suggestion: It would be nice if Jeff could do a video on how your trading day is set up and how and why you chose a certain option.

I know you do not like making a trade for us, so how about a trade in the past.

just a thought
David S

David,

Fair enough. Great idea. Make sure you stay on my case until I get this done.

Everyone else, great comments. Your support and dedication ceases to amaze me.

JK

Jeff,
This whole trading world is quite overwhelming with so much to learn, so many different directions that you can go and so much isolation. You have helped me so much in just knowing your insights and thought processes through good days, bad days and even days when the markets just go sideways. I think it is natural to tend to trade the way that you do, especially in the beginning. Personally, I have been following you with Master Talk since last summer, then the blog, which is exceptional insight, and now the Marketcast as well. I Have to say that I lost a lot in the beginnig but that was my own fault for not developing my own system. I have spent a lot of time tweaking my own system and have had a lot more success. I am actually very interested in learning spread trading and just got a couple of the books that you recommended to attempt to learn more. At this point I think you have taught me well. I am quite determined to make this work and whatever direction I end up going, it will be based on the fundamentals that I feel I have learned from you.

Kudos for you have definately kept me going.
Rene
AL

I have seen some comments about using the ATR for exits. What is the ATR and how is it used?

Bob

Jeff, (and all other bloggers)

I will share my personal crisis here. I lost BIG the week the market took a turn for the worse. Why? Long on options, no stops, went to Canada snowmobiling for a week of fun and foolishly ignored all smart trading discipline. I paid, big. 100K...gone. (yes, that's 100K)

Depressed. Yes. Shocked. Yes. Did I deserve it. Yes. Quitting. Never. Not in my character, not an option! (pun intended)

That was a F@#$ING huge mistake on my part, I got sloppy, and I paid very very dearly.

Like Brett, I have been broken down but will put myself together, pick myself up, dust myself off, and get on to being smarter.

I am fortunate that I am still in the game, but even more fortunate to have found this group on this blog. Nothing like like minded people working together. A great support team.

Losing money is no reason to quit. I can make money. I'd rather lose money than good health, my family, my friends. Money is easier to replace than the aformentioned, and less valuable than my health, family and friends.

So to all that have though about quitting, first re-evaluate the reasons.

I'll be joining others here grabbing one of those "spots".

Lets go CME!! Burn baby burn...

Bob,

There is an amazing article in my archives on the right called "Average True Range."

;)

Thanks Jeff1

I am all over that article ASAP!!

And thanks for this Blog...

Cheers...

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...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT... ...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...I'M AN OPTION ADDICT...

About me

  • I'm Option Addict
  • From Saratoga Springs, Utah, United States
  • I am a professional trader and an instructor for Investools. I've had relations with the markets for 9 years. Born in Concord, CA, but reside in Saratoga Springs, Utah. Father of THREE, Husband of one.
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