How To Increase Your Probability of Success Trading Options

Dan Neagoy

Put 75%+ Odds In Your Favor – How To Increase Your Probability of Success Trading Options

One of the biggest challenges newer traders face is finding a style that “feels right.” For many traders, the process can take a while to sort out and seem discouraging at times.

A common progression is choosing a style and then looking for different markets or stocks to trade. For example, a swing trader might look for stocks that are getting ready to pop higher or sell off for opportunities to get long or short.

Options Income traders do things a little differently. Rather than finding the right setup, options traders generally modify their strategies as the market moves. Instead of making money if the market moves in the right direction, many options traders attempt to make money over a range of prices and even if price stays the same. This affords traders flexibility in finding success trading options.

If you get frustrated trying to pick market direction and think all that “cup and handle/head and shoulders” analysis is nonsense, you just might be an options trader and don’t know it yet. Options Traders are frequently poor market timers and prefer to bet on the probability of something not happening. The benefit of selling options intelligently and with proper risk management is that the positions have the potential to make money even if you’re wrong about market direction.

Benefits of trading options:

  • You don’t need to hunt for stocks on the move and can trade the same, highly liquid market(s) every month. Many income traders only trade the S&P 500, Russell 2000, and Nasdaq.
  • You can use the same strategy or use a handful of strategies regardless of what the market is doing.
  • Instead of looking for a new market you can adjust or change the strategy when the market moves against your position; another way to find success trading options and/or mitigate risk.
  • Make money over a range of prices rather than from “Point A to Point B” or until a stop is hit.
  • Options strategies frequently have a high win rate. It’s not uncommon for options income strategies to have win rates in excess of 75%.

To illustrate how an options trade can make money even if you’re wrong about direction, we’ll look at a sample long setup. The trade below compares buying 100 shares of the S&P 500 ETF (SPY) to selling a put vertical spread. A put vertical spread is similar to selling a put option, but has another long option to cap the maximum risk. The main benefit of selling an out of the money vertical spread is that the options decay over time. As a result, the position can make money if the market moves higher, stays the same, or doesn’t go against the position too much.

Long Stock:

At the time of writing, SPY was trading around 189.35. If we buy 100 shares of the ETF, we know that we’ll make money as long as price continues higher. If price trades below our entry point, we’ll lose money. We can graphically represent our profit and loss with the following payoff diagram:

trading options long stock payoff diagram chart

Put Credit Spread:

This is where things get more interesting with trading options. If we sell an out of the money Put Vertical Spread, we can make money if price moves higher, stays the same, or even declines a bit. The payoff diagram below illustrates a short put credit spread.  This particular spread sells the 180 strike SPY put and buys a 178 strike Put. The spread can be sold for a $48 credit and has a maximum risk of $152. The trade will make money as long as SPY is above 179.56 at options expiration. In other words, the trade has a roughly 10 point buffer over the long stock position.

trading options put credit spread payoff diagram chart

 

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