Options Trading Systems

trading systems

In the last post of this “Learning Options Trading” series, we discussed Options Trading Strategies that you could implement in your trading.

The difficult thing is that there are lots of options strategies and it can be a little difficult to figure out how to actually get started.

There are all kinds of stock and options trading systems which can be anything ranging from a mechanical signal system(following technical analysis indicators) or a more hands on system where you determine your trades based on certain criteria or trading risk/reward plan.

With any trading system, it is best to focus on a couple core options strategies that you build a trading plan around where you:

  • Follow specific selection criteria.
  • Keep consistent risk/reward on every trade.
  • Manage your trades together as a portfolio.
  •  Match your strategies with your trading style and goals.

Step 1 – Create A Trading Plan

Decide on your investment goal. Are you going for speculative, income, long term growth, ecetera.

Then decide on the options strategy that offers the proper risk/reward for your investment goals.

Write out a plan on how you will allocate capital, risk/reward for each trade, specific options strategy for implementing your plan, criteria for selecting your trades.

If you are using a mechanical system then prior to implementing it with real money, make sure you evaluate the past risk vs. reward levels, largest drawdowns, position sizing, minimum account size required. Mechanical systems have losing trades too so you have to make sure that the periods of losses are okay with your risk tolerance and account size.

If you are taking a more hands on investing plan then match your chosen goal with an options strategy that matches it. For example, If you are focused on generating income from options in a retirement account then some of the popular income strategies in retirement accounts are :

  1. Covered Calls – selling calls against your long position
  2. Cash Secured Naked puts
  3. Credit spreads

Start small and really take the time to really understand options basics and how the options strategies really work.

Write out your entry/exit strategy for each position. Pick some criteria for how you will choose you picks.

Step 2 – Implement the Trading System

If you are going to use technical analysis for your stock and options selection then make sure it doesn’t get too complicated.

The more indicators and criteria you use for trying to find stock candidates, the higher the likelihood for analysis paralysis.

For a strategy like covered calls them you are usually holding a position long term and writing calls each week or month on those position. You aren’t as concerned about stock direction short-term with covered calls but it good to have a goal each week for how much income/premium you want to bring in.

You can use technical analysis to determine what strike price for you calls vs. the time value priced into the various strike prices.

For a more active strategy like credit spreads you would be more aware of stock direction for determining strike price, expiration period, put vs. calls.

An example of a trading plan with a more hands-on strategy like credit spreads would be

  1. Goal: income of 15% return on invested capital with 80% probability expiring out of the money.
  2. xxx% of total capital at risk per position.
  3. Determine if stock in defined uptrend(above certain moving averages like 20day/50day/200day)
  4. Is stock near support(sell put spreads) or resistance(sell call spreads) for short and long term trends.
  5. Make sure no major news events prior to expiration and that volatility is normal(not signaling something unusual).
  6. What is my time horizon for the credit spreads(weekly options or monthly options)
  7. Is there enough premium to get the required return on capital in the current expiration period.
  8. What are my exit rules if position goes against me. $ risked determines # of contracts sold.

Step 3 – Document the Results

Papertrade your trading system at first to make sure you feel comfortable implementing it. Once using real money, it is good to start small so you can evaluate your results with less emotion and allow the plan to work(without sabotaging yourself by allowing losses to grow or not following your plan).

If you are stressed while in the trades then reduce your size or re-evaluate you plan. Allow you plan or trading system work. Realize that you will experience losing trade no matter what system you follow so you have to make sure you have properly planned for those periods of losses by properly allocating the right trade size.

STRATEGY TIPS: The important thing to understand with any trading system or style is that you can’t assume something works or not based on only a couple trades. You have to allow a large enough sampling of trades where you apply the same criteria across each trade to determine if the system(or trading plan) works for you. Also, don’t jump around to different strategies. Many traders make a full time living just sticking to one trade strategy.


Learn Options Trading: Main Page

If you have an Option Trading System you like, please share in comments below

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