Successful traders learn to follow a set of rules consistently. These set of rules are called a trading system. When using stock options, it is very important to use a stock option trading system. Traders really need to backtest several stock option trading systems and avoid commonly taught systems that result in a net loss over time. A 'fun' stock option trading system involves high flying stocks Google, CME, or RTP. I call this a 'fun' system because you should only trade with money you can lose. In this system, you should really trade no more than three contracts. The system is for illustration purposes. Remember - options involves risks - including losing your whole account if you do not manage your risk and size you positions properly. The leverage of stock options can cut both ways. You can lose faster as well as win faster with stock options. Therefore, you want to get past the point of trading because of emotions or addiction and trade by your rules. Of course, your stock option trading system needs to be backtested with lots of samples to ensure you have positive expectancy. Positive expectancy means that when you trade many times over the long run, you will have a net profit. You will be surprised that some stock option trading systems being taught or sold may have a NEGATIVE expectancy in the long run. That is, you will be trading at a net loss. They may have worked in a strong trending market a few years ago but they do not work in our current 2005-2006 stock market. One way to see explosive results is to focus on stocks that are expensive and that have a high intra-day range or average true range. Google, CME, and RTP are in the $200 to $500 range. In fact, there are not many other stocks over $200 that have options besides those three. Normally, options two strikes out of the money are relatively expensive for these stocks except during the expiration week. Remember, options basically trade on the stock price difference, whereas stocks trade on the total stock value. A $200 stock with a 5% intra-day range has a 'difference' value of $10. That $10, in absolute terms, can cause some wild swings in option prices during a certain time of the month. Lets look at a stock option trading system that tries to take advantage of expensive stocks fluctuating during the time of the month when options are the cheapest: 1. On the Monday before option expiration, buy three strangles on Google, CME, or RTP that are 2 strikes out of the money for that expiration. For example, on Monday, May 15th, with expiration Friday on May 19th, Google is at 400. Buy the 420 call and the 380 put. If it is not earnings month, the strangle should cost around $300 to $350. 2. Youll have to watch the price quote most of the day for Tuesday, Wednesday, Thursday, and even Friday 3. Try to estimate based on chart patterns whether a certain time is close to the high or low for the day. Better than that, if the price of the total strangle is profitable by $60 or more per strangle, sell one. That's a 20% profit. The normal intra-day range for these three stocks swings enough to cause some profit. 4. Repeat step 3 on Wednesday and Thursday. Many times a year, there is a news event that can cause a $10 to $30 move on a single day. These are the home runs you are looking for that can more than cancel the strike outs of the relatively inactive days. This stock option trading system has precise definitions for entry and relatively precise definitions for exit. Trade like a robot one week a month. In future articles the detailed backtesting results of this system may be presented. Steve Burke http://www.breakthroughbacktesting.com |
