Your 4 Best Trading Strategies Heading Into 2020...
It's no secret I'm a big fan of option trading.
Heck, it's been my profession for about 30 years now.
This blog is filled with educational option trading tips and techniques, and I plan to continue that into the new year (and new decade!)
If you've been reading some of these posts, you should be quite familiar with what I've been trying to get across - that option-selling strategies are your best odds and highest probability trades to make more money.
Why is that?
Because as an option-seller, picking the correct direction of the underlying assets (stocks) is not the sole deciding factor to whether you're profitable or not. That's a huge advantage!
Think about it - if you're a stock buyer, there's only one way to make money, and that's for the stock to move in the proper direction.
The only good thing about stock trading is that you can hold on forever, so in case it moves against you, you can wait it out.
Option buyers don't have that luxury. Not only do they need the stock to move in the proper direction, but they also have to get the timing right before the expiration date.
Yes, all option contracts have an expiration date, and if the stock doesn't make the move in time, the option contract will expire and the option buyer loses 100% of their investment.
Option buyers (like stock buyers) can only win in one scenario - the stock has to move in the right direction.
On the other hand, the option seller doesn't need the stock to move in the right direction.
They can make money if the stock moves in many different ways - up, down, sideways. It's a huge relief knowing you can still win if your directional prediction is wrong. I've written about this exact scenario here and here.
Your Best Trading Strategy #1
Similar to my book, I will highlight the four best strategies to use to make more money in the market. Three of which are option-selling techniques, and the fourth is the only option-buying strategy I recommend.
The first option-selling strategy is - selling covered call options.
If you haven't been selling covered calls against long shares of stock that you already own, then you're leaving money on the table.
Well, for every 100 shares of stock you currently own, you can sell one call option contract and collect the upfront premium payment from the call option buyer. If you own 500 shares, you can sell five call option contracts.
The key is to sell out-of-the-money (OTM) option strikes at a level in which you don't think the stock will move up to by the expiration date.
This way, if the stock doesn't breach the strike price, the option contract will expire worthless, you keep the upfront cash, and you keep your shares of stock.
The reason why you own stock in the first place is to hopefully get price appreciation out of it, and to collect any dividends. Most likely, you want to keep the stock for a long time.
This is why it's important to choose an OTM covered call strike that is well above the current price of the stock. This way, the stock has less of a chance to move above the strike price.
If in fact the stock does breach the strike price at expiration, you will be forced to relinquish your shares, and miss out on any future upside movement. So be sure you pick a strike price that you'll be okay with having to sell your shares.
Selling covered calls can add an extra layer of income to your account multiple times throughout the year. It's like receiving an extra dividend payment.
And as long as the stock doesn't breach the strike price, you can conceivably sell covered calls on the same stock for years on end. Don't miss this opportunity!
A more detailed synopsis can be found here.
Your Best Trading Strategy #2
I don't give this next trading strategy enough press, but I should.
In my book, I called this my "All-Star" strategy and I used it extensively when I was a commodities trader in New York back in the 1990s.
It's a fantastic way to take a directional position while having a much-reduced risk, and it allows for income generation due to the selling nature of the position.
If you have a directional opinion on a stock, you have more choices than to just buy the stock.
You can sell vertical credit spreads using options contracts.
If you are bullish, you can sell put-option credit spreads (bull put spreads), and if you are bearish, you can sell call-option credit spreads (bear call spreads).
For instance, if a stock is at $100 per share and you are bullish, but fear a pull-back may be coming, you can sell an OTM put spread to give yourself some downside cushion while still profiting if the stock moves up.
Doing so allows the stock to make normal gyrations, and even a pull-back, before making the eventual move higher. It gives you staying power.
You can also tailor option spreads to be conservative or aggressive, depending on your outlook for the stock.
With the stock at $100, you can sell an $80/$75 put option credit spread.
How does that work?
An option credit spread consists of selling an option at one strike and buying another option at a different strike, using the same expiration month.
In this case, the option that is sold ($80 put) is more expensive than the option that is bought ($75 put), thus, placing a credit into your account for the difference (spread) between the two prices.
As the stock moves higher, both put option prices shrink, causing the spread to decline in value. This is exactly what an option seller wants, as the spread can either expire with no value, or can be bought back at a much cheaper price than it was originally sold for.
As long as the stock does not fall below $80 by expiration, the spread will expire worthless and the full profit will be realized. That full profit amount is the initial credit that was received at the outset of the trade.
In this case, the stock could remain at $100, move up from $100, or even drop (but not below $80), and the spread will be a winner.
Remember, when selling options, the goal is for the option price to go down, not up. This way, the option can either expire worthless or be bought back at a cheaper price, thus locking in a profit. Sell high, buy low (in that order).
Selling call option credit spreads work in reverse to selling put option credit spreads.
If you are bearish on a stock, but don't want the unlimited upside risk, selling a call option credit spread can play that directional opinion with an upside buffer.
If the stock is at $100, a $120/$125 call option credit spread can be sold. In this case, the more expensive $120 call option will be sold and the less expensive $125 call option will be bought. The difference of the two option prices is the spread and will credited to your account.
The stock could move lower, stay flat or even move higher (but not above $120), and the spread will yield a winner.
Once again, the winning amount is whatever what was collected (spread price) at the outset of the trade.
The dollar risk when selling credit spreads is always capped and known ahead of time and can be calculated by taking the distance between the strike prices and multiplying by 100.
For the put spread: ($80-$75 = $5) x 100 = $500 maximum risk per each spread sold
For the call spread: ($125-$120 = $5) x 100 = $500 maximum risk per each spread sold.
In the end, option spreads yield a limited-risk/limited-reward type of trade that can be applied to any directional position without worrying about unlimited risk, and can give staying power and peace of mind if the stock moves against you.