Lesson 12: The choice of the Options – Second Part

How to choose options, The Choice of the Options, Stock Options, Options Course

How to choose options, The Choice of the Options, Stock Options, Options CourseAfter seeing in last article (the choice of the options) how to choose an underlying, that is the analysis which is the basis of our choice, let's see what strike to use and what are the criteria of choice.

1. Support and resistance. These are price areas where the underlying is not insensitive, and we often see rebounds and reversals. These are the areas where the orders and the stop of investors are going to be crowded.

The support reflects the inability of a market to drop below a certain price level.

The resistance reflects the inability of a market to climb above a certain price level.

As a rule, never sell a CALL option immediately under a resistance and never sell a PUT option immediately above a support.

2. Delta. Delta (δ) is one of the Greeks most used in trading with options. We have already seen another Greek, Theta, in the first chapter and it indicates how much time remains to our option. The Delta, on the other hand, tells us how many odds the market gives to the strike of being reached from the underlying at the selected expiration.

My advice is to always stay under a Delta 20. That is, it means that the market gives less than 20% chance at the underlying to reach the strike.

3. Open interest. It represents the number of contracts open about the option we have chosen. The advice is to select strikes with an open interest of at least a hundred contracts, so we will not have difficulty getting out of the operation.

At this point, after seeing how to choose the strike of the sold option, we will see which strike to the option to buy so that we can complete our Vertical Spread.

My choice is very simple and purely economic. If we go to cover with a very far strike, we will have a bigger premium against a bigger margin. is because covering ourselves with a distant strike it means exposing ourselves to a greater risk.

I will give you an example.

Apple has a price of $ 110.00. We decide to open a Vertical Spread, a Bear Call, selling strike $ 130.00 and buying strike $ 135.00. From this strategy, we get a premium of $ 60.00. By doing the calculations, we see that our biggest risk (which also coincides with the margin required by the broker) is:

Max Loss = ($ 135.00 – $ 130.00) x 100 – $ 60.00 = $ 440.00

So we have an ROI (Return On Investment) of 13.64% ($ 60/$ 440 * 100). Now, always selling the strike $ 130.00, we decide to cover us with the strike $ 140.00. We get to this a bigger premium of $ 90. Doing the same calculation:

Max Loss = ($ 140.00 – $ 130.00) x 100 – $90.00= $ 900.00

So we have an ROI of 10%. Of the two trades, is surely more advantageous the first one that faces a lower risk and offers us a better ROI. So for a matter of convenience, for a purely economic question, at least in the first stage of learning is always better, when we make a Vertical Spread, cover us with the first strike available.

Then, you will see how to increase your ROI further, how to increase the percentage of profit on the capital used. Let's look at how to reduce further the risk of inserting a stop loss strategy.

For example, we get $ 100.00 from an options strategy. What we have to do is insert a stop loss in case the price of the strategy should triple. So we sold a strategy at $ 100.00, and if it came up to $ 300.00, we have to go out there. Then maximum loss:

$300.00 (stop loss) – $100.00 (premium received) = $200.00 (max loss)

So our maximum loss will be twice the premium. Unlike other markets such as ETFs, Forex, Commodities… in selling in options we do not have an R/R (Risk/Reward) in our favour. But even by working in this way, we can get our income over time.

I demonstrate this with an example. Let's put three strategies on the market, each with a $ 100.00 of premium. Two of them go to profit, one to the stop. Then, we will earn $ 200.00 with the strategies at profit and we lose $ 200.00 with the one at stop. So with a 66% (2 out of 3 represents 66%), we have equality.

So it may seem awkward as a strategy, I have to have more than 50% of the profits only to be equal. If you are posting this question, you have forgotten something. Our chances are bigger. The odds of profit, departing, selling options are 75%. But you are not reading this e-Book for the starting odds otherwise you would not need to do it, you would not need to learn. You are here to aim higher, than settling at 75%. Your goal is to get at least 85%.

At this point some of you will think: then I instead to insert the stop at the triple of the premium, I put it to twice so I will have lower losses (and higher gains). Well, that is not true. During the day the options have significant price fluctuations and putting a stop too close to the price means incurring in an excessive number of stops.

Options are like a vegetable garden where we have to let our plants grow to get the fruits. We must give time, space to the strategies to "mature". But to mature how much. Here we come to the expiration argument.

My advice is to go to select an expiration of at least 45 days. This is because even though the underlying initially turned against us, the movement, albeit adversely, will hardly be so strong that we get the stop loss. Do not forget that time is our ally and spent the first few weeks, in the last 30 days we will see "blossom" our premium when the time decay will be felt more and more.

Do not worry, therefore, if our operations will record small losses (theoretical) in the early days, it is normal. A little at a time will give us reason and will reward our patience.

At the end of this article, let's see the entry price and how to best leverage the day-to-day fluctuations in the world of options.

The options move a lot more, over the course of a day than the underlying. It is not uncommon (far from) to see movements of 15-20% of an option with an underlying movement of 1-1.5%. This is because the options amplify the movement of the underlying because each option moves 100 shares of the underlying.

My advice, therefore, is to enter a 15-20% more than the price that the market offers us. So if, for example, an options strategy has a mid-point of $ 0.60, that is if the market offers us $ 60.00 of a premium for selling that strategy, then we will put our entry price at $ 0.70. In this way, we will get a more profitable premium and we will probably do some trade less, but surely with a much higher profit percentage. Finally, having reached a better entry level, we will also have better management of the operation if the market turns against us.

One thing I learned in my life as a trader is that it is not true that those who do more trades earn even more. That is why I advise you to take advantage of the fluctuations the options market offers us.


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