Mitigating risk by using a combined approach
|March 2nd, 2013, 12:27 PM||#1 (permalink)|
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Mitigating risk by using a combined approach
This thread is to talk about options + futures. As a disclaimer, this will not be a "push-anybody's-buttons" thread, nor will it be a forum for weird ideas, but a gentle discussion that encourages positive contributions. (Many of you suspect that I enjoy putting out unpopular ideas, which I sometimes do to encourage debate and spark thoughtfulness. But I don't do it all the time )
For a good discussion of using options by themselves, I suggest you go to the "Selling Options" thread which was started by Ron99 and where there is a good discussion going on by him and other experienced people who have been doing it for a long time, know what they're talking about, have gotten to the point where they are consistently profitable and can help you learn.
I personally use an options + futures combined approach. I feel that futures or stocks by themselves are quite risky and using options is necessary. I mostly buy options, but my strategy sometimes calls for selling premium and spreading.
When I sell premium, I do it when I would like to (or don't mind) being exercised on the underlying product. That is, when my method in futures would take a buy or short sell anyway.
This would be a good starting point for those of you who have been trading a naked product and would like an introduction into options: Let's say you are thinking about buying a stock, but you won't buy unless it dips down to a certain price. In this case, consider selling a put at that strike. If you sell a put, the premium is applied as a credit to your account when it expires. If the price of the stock never goes down to that strike price, then you make some money on the premium where you wouldn't have made anything otherwise. If the stock price goes in the money at any point, treat it on paper as if you had initiating the trade in the stock at that point and proceed to develop the trade as you normally would. At expiration, if you are in the money, let the option be exercised, thereby making you buy the stock at the strike price. This has the additional benefit of you making money on the premium for something that you would do anyway (buy the stock.)
Let's say you are a long term investor in a company whose current share price is $100. You plan to buy shares of the company if the stock price goes down to $95.00. you will buy more shares if it goes even lower to $90.00. I'm not saying this is a "good" strategy or a "bad" strategy (whether a strategy is good or bad depends on context), but it is *your* strategy for whatever reason. So, in this case, you should consider $95.00 puts and selling $90.00 puts, and holding them until they expire.
Now some general education on options. They are actually very simple: Think of them like this:
With options you are making bets on one of the following scenarios:
(a) the price of the underlying instrument will be above a certain point at expiration
(b) the price of the underlying will be below a certain point at expiration
(c) the underlying price will be within a specific range at expiration
(d) the underlying price will be outside a specific range at expiration
That's it. That's all there is to it. You can construct combinations of options (called spreads) which allow you to bet on any of those kind of scenarios.
If you sell more premium than you buy, this is a "credit"[/U] to your account.
If you buy more premium, this is a "debit"[/U] to your account.
when you buy options, or sell them, or do spreads, always determine the underlying price that makes for the maximum risk. This is always known beforehand. You can always sit down and do some basic math to determine this value, so be sure to do it so that you know what you're (possibly) getting into. Different option strategies give you different combinations of limited or unlimited rewards and risks.
As with all trading, options or otherwise, a single trade is not statistically significant. What matter is how many wins and losses occur over lengths of time. So, once you get your stock strategy, futures method, or options strategy, it is a good idea to backtest as much as possible so that you can gather the probabilities of wins and losses over many, many trades. If you are winning more often than losing (or a smaller number of bigger wins versus more smaller losses), then you have a good overall trading strategy.
Last edited by mwtzzz; March 2nd, 2013 at 12:35 PM.