The longer you are actively trading in the market, the more you see. There are strategies that work for months, even years, but may blow up in your face all the sudden.
Here are the things I am mindful of, when trading options:
1. Close relevant positions a few days before highly anticipated announcements
If the market is overly anticipating and anxious about an upcoming announcement, it’s best to not have any open trades going into the announcement. The markets can be very volatile, and a knee jerk reaction can totally ruin a position. IV will build going into the date of the announcement, sort of like an earnings trade.
Strong moves can follow such announcements, where implied volatility increases several fold. As a result, options trades will be very difficult, if not impossible to manage. And to make things more interesting, the knee-jerk move may even be followed by a retrace, so even if you adjust your position after the announcements, it may go back against you.
For example, this is what I mean, this was the much anticipated non-farm payroll announcement on 12/04/2015. The abrupt move might have spooked you into adjusting your position, only to have things fall back a few minutes later:
2. One contract is enough to begin with
It’s best to open small positions, since in case you need to adjust them, maybe double or triple your position, you can still do it, without hesitation. If you have a larger opening position, it becomes difficult to manage it both psychologically, and financially.
For example, I had a natural gas short strangle (NGZ5), which went all wrong. NG fell a lot in a very short time, and since I had 2 initial contracts, my “floating” loss was huge, 10% of my account size. That’s the psychology part, it sucks to look at such a big theoretical loss, even if it’s not “real” yet. I could have adjusted the position and would have ended in profit, but I would have had to triple my position to do so. That was too much of a risk, and I didn’t do it, since I didn’t want the risk of 6 contracts going sour.
Keep it small, so you can adjust later freely.
3. If you go on vacation, close your positions
Even if things seem super safe, it’s best to close your positions if you won’t have normal access to your trading environment.
For example, I had an NG short strangle (NGX5) which had 2 days to expiry. It was at maximum profit, and the put side of the strangle was 12% away. You could say it’s a safe bet to keep it on till expiry. But you would be wrong, as was I.
NG crashed down 10% the next day, and another 3% the following. I had no chance to intervene, since I couldn’t place trades. I could have banked maximum profits prior, but I thought it was safe, so I thought I would save myself the bid-ask spread and commissions.
4. Manage your winners
Once you got a winner, don’t let it go against you, especially if you’re doing non-directional trades with OTM options. Theta works early with OTM options, and slows down after 25-30 DTE. The exact opposite of ATM options.
Close those puppies at 50-75% profit, and move on to the next trade.
5. If a trade really goes against you, the main objective is to break even and close the trade
Oh how many times I’ve had this happen. Short strangle, one of the sides tested, implied loss getting higher and higher. After a few trade modification and some time, trade starts working out again, as the price of the underlying goes back into a correction. Strangle is at break even, smile on my face, no problems. Than BAMM. Trend continues against me. Argh.
Close those suckers out at break even if they really go against you. In the long run, the normal winners will be your profit, you don’t need to deal with big losers.
6. Expected market range
The expected range of price action for any given time period will be 1 standard deviation.
The way to calculate this, is to divide the underlying’s implied volatility by the following, depending on the period you’re calculating:
- Day range: 19.1
- Week range: 7.22
- Month range: 3.5
So if USO is 9.77 with an IV of 61.77% right now for the option expiring in 7 days, and I want to find the weekly expected trading range, I divide 61.77%/7.22 = 8.55%.
This means that the expected range of USO for the next 7 days is +-8.55% of the current price.
7. World financial meetings are to be avoided (ie. Davos)
Every so often, prominent world leaders and other millionaires/billionaires meet to exchange thoughts about world economy. Opinions from these leaders of the world have a definite effect on the financial markets, so it’s best to avoid having open positions going into such events.
What kind of positions am I talking about? Major ones, like currencies, oil and treasuries.