Developing systematic approach to trade Options

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Most of the time, new option trader gets lost in the maze of so many option strategies and find it difficult to select right strategy for correct market condition.
Let me give you a framework for strategy selection

1) Decide your holding period of the trade – intraday, few days, weeks, till expiry etc
2) Decide on your view about the market for above time-frame – up, down or sideway.
3) Asses the current volatility scenario of market – high, low, normal.
This will give u a 3×3 matrix. It it seems too complicated, then you can drop volatility for now. So you have 3×1 matrix.
4) Option trading has all kind of strategies to play above 3 market conditions and 3 volatility situation. From that lot, select 1 or 2 strategy for each type of market condition.
5) Master the selected strategies. Know their risk graph, break-even points, maximum risk, maximum return, behaviour for change in various option Greeks etc.
6) Develop your personalised trading system for each strategy. Address the decision variables like which strike, which expiry month, how much of premium to collect, when to trade and when not to trade this strategy, where to put stops, your action plan when position goes in your favour, against you, or goes nowhere.
7) Backtest, paper trade, etc and get a feel of trading them in paper. Make sure that your personalised trading system has positive expectancy.
8) Put your risk management plan, trade planning etc in place
9) Start trading your trading system

Hope this helps you in developing your personalised option trading strategy.

Happy Trading

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4 Comments on “Developing systematic approach to trade Options”

  • satya
    27 May, 2010, 18:22

    Can you provide a detailed post for 9 what if scenarios.Or for at least 3 what if scenario.

  • Trader anup
    30 May, 2010, 5:28

    Thanks Satya, Before you goto step 9, one got to complete all previous steps and define the system with very clear rules. Following post will help in planning individual trades and various exit conditions.
    Each section of this trading plan, should be addressed clearly in your system definition.

    http://niftyoptionstrader.com/how-to-plan-an-options-trade/

    Please check out above link and let me know if you still have any confusion.

    Happy Trading.

  • Raunak Agarwal
    15 June, 2010, 16:56

    Anup, 

    I have one question. 

    Scenario: Lets say I expect the markets to go below 4800. Currently being at 5220. 

    Case: What if I short August 2010 Futures of Nifty. Lets say 200 Quantities. Now if market goes against me in short term, I do keep faith in my system and hold my position. Obviously this come with a cost; Stress.

    Now what can I do here with options to lower my risk and my stress levels. If I am short on August 2010 Futures, should I buy August calls for protection? How do I structure this? 

    Tc

  • Trader anup
    16 June, 2010, 16:22

    Raunak, I have written following post to answer your query. Please refer to this post
    http://niftyoptionstrader.com/how-to-hedge-short-futures-position-using-options/

    Happy Trading

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