Author Topic: Learning to trade options  (Read 2358 times)

Dreamer

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Learning to trade options
« on: October 05, 2017, 12:19:29 PM »
I have done some reading about options trading, and would really like to use them in my investment portfolio.  However, I don't feel confident enough in my understanding to actually jump in and trade them.   Can anyone recommend a good book to help me get started?  I do have plenty of experience trading stocks.

mjchamb

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Re: Learning to trade options
« Reply #1 on: November 26, 2017, 06:46:21 AM »
I would recommend the Blue Collar Investor stuff- I learned most of what I know from that, and am currently trading options in my Fidelity IRA with rollover $ from an old employer. Their material is very well laid out, and contains a lot of information beyond what you would find by just googling or buying a waste of money ebook on amazon. It actually goes so far as to lay out an entire system of trading- most things you read out there will only explain how options work without getting into more detail on how to manage trades.

I am very wary of material that may just be a "pitch" for some type of service, but their membership service is simply a weekly email of all the stocks they have screened from the IBD 50 using about 4 technical indicators and some fundamental analysis, which the books teach you how to do in-depth... so you can do it all yourself and forgo paying them a monthly fee.

The one thing to consider is that they only use covered calls and cash-secured puts, but that is the best place to start learning, as all other options are just a combination of puts and calls. Furthermore, if you are trading in an IRA, those are the most complex options you can utilize anyway.

http://www.thebluecollarinvestor.com/store/

Word of warning! The online store is set up poorly and some of the products are redundant- just get the Complete Encyclopedia for Covered Call Writing- Classic Edition which actually contains the material in the "Cashing in on Covered Calls" book and the Exit Strategies book (and make sure you don't accidentally buy volume 2 of the encyclopedia until you have read volume 1). The 0.99 cent ebook on greeks is worth the price if you wish to go more in-depth, but not really necessary unless you like to geek out over the technical aspects like I do. Selling Cash-Secured Puts is the best one to go to after you read the Covered Call Encyclopedia.

Word of Warning #2: don't buy the books from amazon unless you have checked the price- some people are "drop shipping" them for $20-$40 more than if you bought directly from the site- I made the mistake and ended up kicking myself for it.


DM me if you want to talk options more- I'd be glad to share my experiences/have someone to bounce ideas off of.

Cheers!




Financial.Velociraptor

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Re: Learning to trade options
« Reply #2 on: November 26, 2017, 08:35:15 AM »

The one thing to consider is that they only use covered calls and cash-secured puts, but that is the best place to start learning, as all other options are just a combination of puts and calls. Furthermore, if you are trading in an IRA, those are the most complex options you can utilize anyway.


You can make plenty of money (while lowering your risk) with these two strategies.  Most options traders will never need to do anything more complex.  Recommend not venturing into deeper water until at least two years of trading options.  That is a huge part how I was able to retire early with a higher than normal withdrawal rate.

GoCubsGo

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Re: Learning to trade options
« Reply #3 on: December 01, 2017, 11:58:12 AM »
Thx mjchamb! I just spent an hour watching the Blue Collar Investor video series for beginners.  Seems to have a pretty straight forward teaching style combined with common sense.  I too have an old Fidelity IRA I'd like to start trading option on (looks like I need to call Fidelity in order to enable the options feature on the site). I am going to order the Encyclopedia and see how comfortable I am starting some simple trades from there.

mjchamb: Can I ask how quickly you started making trades and what your level of knowledge was as a starting point?

Financial.Velociaptor- I've read your blog a few time and I love your transparency (don't understand the exact machinations of your trades quite yet, but it's good to read)

TIA

ILikeDividends

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Re: Learning to trade options
« Reply #4 on: December 01, 2017, 02:51:18 PM »
I have done some reading about options trading, and would really like to use them in my investment portfolio.  However, I don't feel confident enough in my understanding to actually jump in and trade them.   Can anyone recommend a good book to help me get started?  I do have plenty of experience trading stocks.
Why not get the skinny straight from the horse's mouth (CBOE)?

http://www.cboe.com/strategies/strategies-main

Strategies broken down by beginner, intermediate, advanced, leaps, etc.

Tons of info available for free.  And it's something to do while you're waiting for Amazon to ship your book, if you go that route, too.  ;)
« Last Edit: December 01, 2017, 04:19:11 PM by ILikeDividends »

ChpBstrd

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Re: Learning to trade options
« Reply #5 on: December 03, 2017, 08:53:13 PM »
Even those who understand the technical mechanics are sometimes surprised by the price action. It's still something of a mystery to me.

If your brokerage offers a "paper trading" account, this might be a good sandbox to learn in. Check the pricing action daily to get a feel for what happens if the stock goes up x% or down x%.

PizzaSteve

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Re: Learning to trade options
« Reply #6 on: December 06, 2017, 03:08:18 PM »

The one thing to consider is that they only use covered calls and cash-secured puts, but that is the best place to start learning, as all other options are just a combination of puts and calls. Furthermore, if you are trading in an IRA, those are the most complex options you can utilize anyway.


You can make plenty of money (while lowering your risk) with these two strategies.  Most options traders will never need to do anything more complex.  Recommend not venturing into deeper water until at least two years of trading options.  That is a huge part how I was able to retire early with a higher than normal withdrawal rate.
one can also lose money or be forced out of winning positions in good stocks (with tax implications) following these strategies.  fair warning....i lost considerabe upside on a great stock writing covered calls, which were cashed in 6 mo prior to expiration.  i would advise avoiding the temptation. options are rarely misspriced in ways retail investors can exploit.

anisotropy

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Re: Learning to trade options
« Reply #7 on: December 09, 2017, 12:25:50 PM »

one can also lose money or be forced out of winning positions in good stocks (with tax implications) following these strategies.  fair warning....i lost considerabe upside on a great stock writing covered calls, which were cashed in 6 mo prior to expiration.  i would advise avoiding the temptation. options are rarely misspriced in ways retail investors can exploit.

I agree, the option traders I know that make money all use technicals. Not to mention they rarely interp the same with each other.

mjchamb

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Re: Learning to trade options
« Reply #8 on: December 10, 2017, 05:56:23 PM »

mjchamb: Can I ask how quickly you started making trades and what your level of knowledge was as a starting point?

Financial.Velociaptor- I've read your blog a few time and I love your transparency (don't understand the exact machinations of your trades quite yet, but it's good to read)

TIA

To answer: I learned from a physician I used to work with a long time ago (~5 or 6 years in the past). He mainly sold intermediate to long term puts on stocks, and would buy them back when enough time value had eroded or the equity price rose. I myself sold covered calls, but mostly for fun at the time- typically smaller cap biotech. I'm an oncology pharmacist by trade, so I tried to pick drugs that I think had great market potential if approved so that I wouldn't be disappointed if i had to hold it for long time in case of a "gap-down" in price. Because the drugs were in the Phase I/II trial stage, I could extract a lot of value from the volatility. I remember playing around with ACAD (Acadia pharmaceuticals) a lot at the time. Currently I'm doing that with SGMO. If you want to paper trade that type of thing for fun, plot a Bollinger band and sell a call at the top and buy it back when it hits the lower one, rinse, and repeat. I'm doing it with SGMO right now, who recently started the first human trial with a gene editing technology similar to CRISPR (don't do that with all your money though, because bad trial results can completely wipe you out. It is more gambling for fun and learning the mechanics of covered calls at a fast pace than it is a long-term investment strategy).

I found MMM about a year ago and have been saving and investing seriously since then. I re-read a lot of the Blue Collar Investor stuff and some other, more formal books (Options as a Strategic Investment by McMillan is an amazing text- very straightforward and thorough), and paper traded a few months before starting to trade in my IRA about 4 months ago, but I am tempted to change my strategy to trading collars in a taxable account because I like the idea of having a limited loss. I have to save up more capital to do that, though.

So probably about 3 months learning, 3 months paper trading, 4 months actual trading. I am admittedly still a little "timid" and am not deploying all of my capital at the moment.

I also would like to shout out that I love financial velociraptor's blogroll and posts on here- both are very transparent, which is hard to find, even on investment sites you might pay a membership for. If you are ever tempted to do something like that, just check out http://investimonials.com/ first- it can be pretty entertaining. Also, buying long-term puts on a leveraged ETF like UVYX is imho GENIUS and I am kicking myself that I never realized that strategy, even though it was staring me in the face for quite some time.

anisotropy

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Re: Learning to trade options
« Reply #9 on: December 11, 2017, 12:34:19 PM »
plot a Bollinger band and sell a call at the top and buy it back when it hits the lower one, rinse, and repeat.

ya that's a very common practice. I used to use it for wti crude.

ChpBstrd

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Re: Learning to trade options
« Reply #10 on: December 12, 2017, 03:28:23 PM »
Quote
Also, buying long-term puts on a leveraged ETF like UVYX is imho GENIUS and I am kicking myself that I never realized that strategy, even though it was staring me in the face for quite some time.

I'm attempting to craft a strategy where I do a synthetic short on UVXY and hedge that with some proportion of a synthetic long on VXX. This would be the ultimate all-weather hedge and would essentially earn the contango, fees, and inefficiencies that cause UVXY to so poorly track VIX. I just have to figure out the proportions of each, which is tough because of differences in volatility and generally irrational, low-liquidity pricing*.

*you'll notice that your UVXY puts are sometimes quoted as rising when UVXY falls, and vice versa.

ILikeDividends

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Re: Learning to trade options
« Reply #11 on: December 12, 2017, 05:08:55 PM »
Quote
Also, buying long-term puts on a leveraged ETF like UVYX is imho GENIUS and I am kicking myself that I never realized that strategy, even though it was staring me in the face for quite some time.

I'm attempting to craft a strategy where I do a synthetic short on UVXY and hedge that with some proportion of a synthetic long on VXX. This would be the ultimate all-weather hedge and would essentially earn the contango, fees, and inefficiencies that cause UVXY to so poorly track VIX. I just have to figure out the proportions of each, which is tough because of differences in volatility and generally irrational, low-liquidity pricing*.

Why not hedge by adding a long OTM call into your synthetic short of UVXY?

The difference between the strikes of the short ATM call and the long OTM call would define your risk with certainty.

My biggest concern with using a different index to hedge is that you'd have to leg into the position with two different trades.  The nightmare scenario would be if you establish only one leg of the trade, and then the market takes off on you in the wrong direction, before you can get your hedge in place.

That potential suggests that you might be inclined to rush into establishing the 2nd leg of the position at a less-than-optimal price.  You would then face similar problems in exiting the position.

*Note: I do see the attraction of the theoretical reduced cost of pairing a synthetic long with a synthetic short, but you would only realize that benefit if you got favorable pricing on both legs of the trade; both when entering, and when exiting.

**Note: Since those two indexes seem to correlate quite closely, it seems your profits on UVXY would almost always be offset by corresponding losses on VXX; even if you could enter & exit with precision.  Maybe I'm missing something?

***Note: This whole UVXY discussion makes me think that an outright naked short of UVXY might be the odds-on way to go, in order to eliminate the crazy effects of implied volatility on the options against that index altogether.  But that thought is for those less timid than I. I prefer to set defined limits on what I might lose. ;)

*you'll notice that your UVXY puts are sometimes quoted as rising when UVXY falls, and vice versa.
I've seen this too.  There must be a way to exploit this.

Shorting the index, with a long ATM or OTM call as a hedge (it's the mirror image of a buy-write), might be the way to go.  It would seem possible, depending on circumstances, to both exit your short stock and your long call profitably, and then re-establish the position at a lower strike, later. I'm going to have to think about that!

« Last Edit: December 12, 2017, 07:27:58 PM by ILikeDividends »

jjcamembert

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Re: Learning to trade options
« Reply #12 on: December 12, 2017, 05:56:56 PM »
Tastytrade.com has a ton of free info from beginner to advanced. They focus mostly on selling options to reduce cost-basis. I think the best part is that they do research to back their claims and they teach the mechanics of defending trades gone wrong. All of their content is free and they're not trying to upsell you to their course/seminar/ebook/whatever.

Also https://www.reddit.com/r/options/ is a pretty good forum for asking specific questions. Lots of knowledgeable people on there.

Financial.Velociraptor

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Re: Learning to trade options
« Reply #13 on: December 12, 2017, 08:05:06 PM »
***Note: This whole UVXY discussion makes me think that an outright naked short of UVXY might be the odds-on way to go, in order to eliminate the crazy effects of implied volatility on the options against that index altogether.  But that thought is for those less timid than I. I prefer to set defined limits on what I might lose. ;)

I have tried this and it is a "hard" way to make money.  The borrowing fees can be quite high (over 100% annualized during ^VIX spikes and about 25% during low vol times.)  The worst part is during ^VIX spikes, shares available to short dry up.  You get forced out of the trade at the worst possible times.  With a long put, you control your destiny, pay no borrow fees, and have defined risk.  It is theoretically less lucrative than a naked short but a lot more reliable.  I have also shorted naked calls.  Watch your position sizing closely if you do that.  I got greedy several years ago with naked calls on VXX and saw more than my annual salary evaporate when the Greek debt crisis broke.  Made me appreciate the long put strategy!

ILikeDividends

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Re: Learning to trade options
« Reply #14 on: December 12, 2017, 08:23:49 PM »
***Note: This whole UVXY discussion makes me think that an outright naked short of UVXY might be the odds-on way to go, in order to eliminate the crazy effects of implied volatility on the options against that index altogether.  But that thought is for those less timid than I. I prefer to set defined limits on what I might lose. ;)
I got greedy several years ago with naked calls on VXX and saw more than my annual salary evaporate when the Greek debt crisis broke.  Made me appreciate the long put strategy!
But what if you had shorted the underlying, and gone long the calls as a hedge against the short on the underlying (rather than short the calls)?

Have you ever tried that? Or are you saying that there are ongoing expenses to maintaining the short position, beyond entering the position? UVXY doesn't pay a dividend, so I don't understand where the ongoing maintenance expense on the short side would come from.

Since implied volatility is so low these days, I wouldn't ever consider a short call or a credit spread on UVXY, but I'm likewise thinking that hedging with a long call would be a cheap way to hedge a short position on the underlying, entered only during low volatility periods.  That discipline could keep you out of the trade during an extended high volatility period (a good thing).

The short on the underlying should move dollar-for-dollar with the underlying, though the depreciation or appreciation of the long call would generally not track the underlying as precisely (it would be variable, nevertheless); it would still retain its utility as a hedge, regardless of the unpredictable effects of volatility on its pricing.

But the UVXY option pricing in relation to volatility is so through-the-looking-glass, that I could easily be missing something.
« Last Edit: December 12, 2017, 09:36:59 PM by ILikeDividends »

Financial.Velociraptor

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Re: Learning to trade options
« Reply #15 on: December 12, 2017, 10:27:51 PM »
***Note: This whole UVXY discussion makes me think that an outright naked short of UVXY might be the odds-on way to go, in order to eliminate the crazy effects of implied volatility on the options against that index altogether.  But that thought is for those less timid than I. I prefer to set defined limits on what I might lose. ;)
I got greedy several years ago with naked calls on VXX and saw more than my annual salary evaporate when the Greek debt crisis broke.  Made me appreciate the long put strategy!
But what if you had shorted the underlying, and gone long the calls as a hedge against the short on the underlying (rather than short the calls)?

Have you ever tried that? Or are you saying that there are ongoing expenses to maintaining the short position, beyond entering the position? UVXY doesn't pay a dividend, so I don't understand where the ongoing maintenance expense on the short side would come from.

Since implied volatility is so low these days, I wouldn't ever consider a short call or a credit spread on UVXY, but I'm likewise thinking that hedging with a long call would be a cheap way to hedge a short position on the underlying, entered only during low volatility periods.  That discipline could keep you out of the trade during an extended high volatility period (a good thing).

The short on the underlying should move dollar-for-dollar with the underlying, though the depreciation or appreciation of the long call would generally not track the underlying as precisely (it would be variable, nevertheless); it would still retain its utility as a hedge, regardless of the unpredictable effects of volatility on its pricing.

But the UVXY option pricing in relation to volatility is so through-the-looking-glass, that I could easily be missing something.

When you short a stock, there is a borrowing fee.  It can actually be negative during high interest rate times.  But for UVXY, the rate is punitive.  Most of your profits will be lost to borrowing fees (shows up as interest in your brokerage report).  Sometimes, your net return will be negative.   And you can find yourself in times of high volatility with no shares available to borrow.  Your broker will close you out at market at a loss.  I've tried it and it just doesn't work.  The hedge might solve that but expect to lose on the underlying short.

ChpBstrd

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Re: Learning to trade options
« Reply #16 on: December 12, 2017, 10:42:15 PM »
I've considered the long straddle or strangle approach I believe you brought up, ILD (i.e. buy a put + buy a call). It makes sense on an intuitive level. The one thing this firecracker is least likely to do is sit still.

Also, when Dear Orange Leader launches airstrikes on North Korea via Twitter while pissing on the Western Wall in Jerusalem, it will be nice to say "well, I didn't expect to make my money on that leg of my straddle."

A long straddle could, in theory, make money on UVXY's 90% per year drag *WHILE* simultaneously hedging the rest of your portfolio against a "volatility event". Get paid to buy insurance!

The hard part would be figuring out when you've made enough money to exit the trade and re-center with more duration. After a couple of trade adjustments (selling your appreciated spread and buying a cheaper spread at a lower strike), you could soon be in a position where it would be impossible for the overall trade to swing into the red.

Verticals would also be a good way to either exploit UVXY's downward tendencies or lose a fixed amount - the strike spread plus/minus your credit/debit. Naked calls are too risky on something that could climb 10x on a rough day - NOPE! The point of the exercise is to find a trade that you could safely allocate more than play money to, and your straddle idea has merit.

Quote
The short on the underlying should move dollar-for-dollar with the underlying, though the depreciation or appreciation of the long call would generally not track the underlying as precisely (it would be variable, nevertheless); it would still retain its utility as a hedge, regardless of the unpredictable effects of volatility on its pricing.

My long puts with over a year duration on them only move by about 10-20% of what UVXY moves in a given timeframe. The delta is a very rough approximation of what to expect. The only time I've ever lost money on UVXY puts in my one year of trading was when I got greedy and went with only about a 3 month duration, then got whacked by a routine volatility event with no time left to recover. With the long durations, though, you could probably hold through a typical recession and still make money. It's weird. You could even buy-n-hold these options for long-term capital gains!

ILikeDividends

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Re: Learning to trade options
« Reply #17 on: December 13, 2017, 05:56:50 PM »
Thank you FV and ChpBstrd, for your thoughts and explanations. 

I have just modeled a simple bear put debit spread, spanning two strikes, a 12 strike for the long put, and a 10 strike for the short put, having a duration of about 1 month.  I'm using after hours quotes, so there might be some wonkyness there.  Also, I'm assuming both puts can be bought/sold at the midpoint between bid and ask.

The intent of the model is simply to ride this spread through expiration 12 times a year, adjusting each subsequent month's spread to be +1 and -1 from ATM; the classical bear put debit spread.

With those assumptions, you can put this spread on for a net 0.57 debit.  This is your defined risk.

If both contracts expire in the money, you collect a net $2.00 after exercise (a net $1.43 profit after the debit to enter the position).

If both contracts expire out of the money (e.g., a volatility event) you lose 0.57.

If only one contract is in the money at expiration, then you exit with something less than a 0.57 loss.  For this scenario, you need to make sure you have enough cash or margin in the account for your broker to buy the underlying so as to assign it with the long put.  For the sake of simplicity, I'll declare this an outlier event, and ignore it.

I'll be damned if I can figure out an annualized return on this, but let's use "risk" as the denominator, and the net profit after the debit to enter the position, less the debit again, as the numerator. This assumes a 50/50 win/lose ratio.

So if you win this speculation 6 months out of the year, and lose it 6 months out of the year (which seems to be a highly conservative assumption), then your "annualized return" (defined as return on risk) is a tad over 150%.

If you win more often than you lose, then your annualized return goes up correspondingly. You can lose this trade 8 out of 12 months, and still eek out a 25% annualized gain (using realized losses in place of risk, and realized profits, net of losses, in the calculation).
« Last Edit: December 14, 2017, 01:08:44 PM by ILikeDividends »

katsiki

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Re: Learning to trade options
« Reply #18 on: December 13, 2017, 08:25:06 PM »
I don't know anything about options but I received an email today that Robin Hood will be offering free options trades.  It reminded me of this thread.  Maybe some of you folks will find that useful.

ChpBstrd

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Re: Learning to trade options
« Reply #19 on: December 14, 2017, 02:43:46 PM »
Interesting play, ILD.

I appreciate your well written rationale too. I suspect all the computers using delta to set probabilities/pricing on these options are measuring the wrong thing, given the design of UVXY. I might switch to this approach to remove a few naked put time bombs from my portfolio.

Financial.Velociraptor

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Re: Learning to trade options
« Reply #20 on: December 14, 2017, 03:00:36 PM »
Thank you FV and ChpBstrd, for your thoughts and explanations. 

I have just modeled a simple bear put debit spread, spanning two strikes, a 12 strike for the long put, and a 10 strike for the short put, having a duration of about 1 month.  I'm using after hours quotes, so there might be some wonkyness there.  Also, I'm assuming both puts can be bought/sold at the midpoint between bid and ask.

The intent of the model is simply to ride this spread through expiration 12 times a year, adjusting each subsequent month's spread to be +1 and -1 from ATM; the classical bear put debit spread.

With those assumptions, you can put this spread on for a net 0.57 debit.  This is your defined risk.

If both contracts expire in the money, you collect a net $2.00 after exercise (a net $1.43 profit after the debit to enter the position).

If both contracts expire out of the money (e.g., a volatility event) you lose 0.57.

If only one contract is in the money at expiration, then you exit with something less than a 0.57 loss.  For this scenario, you need to make sure you have enough cash or margin in the account for your broker to buy the underlying so as to assign it with the long put.  For the sake of simplicity, I'll declare this an outlier event, and ignore it.

I'll be damned if I can figure out an annualized return on this, but let's use "risk" as the denominator, and the net profit after the debit to enter the position, less the debit again, as the numerator. This assumes a 50/50 win/lose ratio.

So if you win this speculation 6 months out of the year, and lose it 6 months out of the year (which seems to be a highly conservative assumption), then your "annualized return" (defined as return on risk) is a tad over 150%.

If you win more often than you lose, then your annualized return goes up correspondingly. You can lose this trade 8 out of 12 months, and still eek out a 25% annualized gain (using realized losses in place of risk, and realized profits, net of losses, in the calculation).

I did roughly this in late 2012.  I went into the money thought to reduce my risk.  I set up a separate brokerage account just for this strategy and went big.  My problem with the strategy was about 1/3 months I got assigned early.  Since I was buying an enormous number of contracts, I got margin calls.  The brokerage website went into convulsions due to margin violation restrictions so it was enormously difficult to unwind the position even though (additional) risk was trivial.  I seem to remember I was making 8% a month on the value of the entire account.  Actual return was somewhat lower because my tax treatment included a lot of wash sales on unwinding the put.  (for some reason I wasn't permitted to exercise the put to zero out the trade when under margin violation). 

Your strategy works gangbusters, it just requires "small" position sizing.  Maybe that is for the best.

ILikeDividends

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Re: Learning to trade options
« Reply #21 on: December 14, 2017, 03:22:54 PM »
Your strategy works gangbusters, it just requires "small" position sizing.  Maybe that is for the best.
That is precisely what attracted me to it.  With 10 contracts on each leg, you can get in for about $570.  If you lose that month, then that's what you're out.  If you win, you net $1430, after expenses.  You can lose quite a few months, and still do ok.

Since these are such short-term options, they will decay rapidly.  That increases the probability that you can exit, before expiration, at near-full profit, and roll the trade down and out for another month after that.  This dynamic, alone, might allow you to put on 13 or 14 trades per year.  I would consider this tactic more a reduction of risk, rather than a profit enhancer.

If I only win 50% of the time, that covers roughly a quarter of my monthly living expenses right there (before taxes).

Another thing I like about it is because of this nagging feeling at the back of my head that someday volatility will return to more historical norms.  If or when that happens, this trade allows you the agility to pivot with the "new normal" without taking a very big hair cut.
« Last Edit: December 14, 2017, 09:45:09 PM by ILikeDividends »