Is options trading difficult ?

This item was filled under [ FAQ, Traders zone ]

Recently, I was asked by a trader who is new to options trading – “It seems it is difficult to formulate a proper trading system for options. Firstly one has to establish a view on the the market viz rangebound or trending (up or down). After that, looking at the volatility one has to select the right options strategy. Then there are so many strike prices available so take another decision to select the right strike price”.

My reply to him was – All the point that you have mentioned are valid.
Market goes through different phases and we have to have tools for each phase. One tool can’t fit everywhere. Strategies that work in rangebound market, fails in nice trending market and vice-versa.
Same is true for options as well.

Most us know that market remains in 3 trends – Up, Down and No trend i.e Rangebound.. And out of these 3 phases, market spends 40 to 50% time in range or sideway move. Unfortunately, trading literature and most of the people don’t talk too much about strategies for rangebound market. When market is rangebound and one tries to implement a trend-following strategy(like MACD based, moving average based etc), then it certainly will keep hitting the stops.

So how to identify the current state of market should be the base for any type of trading. If anybody is serious about trading then this should be the first thing to learn (I learnt it thru hard way by paying too much of tution fee to the market).

I agree that option trading is not straight forward like stock or futures but amount of flexibility it gives to manage risk, makes it worthwhile to take the pain to understand it. And yes, you can develop many trading strategies. It is not that difficult, provide we take one step at a time and follow logical sequence to take decisions.
Options trading give us so much flexibility that we can trade all 3 market conditions with limited risk. Infact, some of the strategies can be great holiday trading strategy where u open the trade with well defined risk and just let it run till expiry without monitoring it daily. Your risk is so well defined.
One might say that putting stoploss order takes care of it for stock/future trade as well but there are cases when stoploss order might not get executed, if the trigger price is not traded by the market.. That type of risk does not exist in well thought-out option strategy.

Following are the steps that I will suggest to develop option trading strategy
1) Identify current trend of the market – up, down or sideway
2) Start selecting one market condition and find suitable option strategy for it
3) Write down your rule for Setup or precondition, Entry, Stoploss Exit, Target Exit, Trailing stop
4) Backtest it.. and analyse the results
5) If results are unacceptable the try to improve the rules and test again..

Happy Trading

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