2 Simple Strategies to Navigate Options Trading
October 26, 2017, 10:21 am
I know how overwhelming it can be when you want to try your hand at trading options but there’s so much information available that it’s hard to make sense of it all. Options are a great vehicle for trading, and I don’t want you to avoid them (although it’s very important to consider your risk tolerance before investing) just because it seems like there’s a lot to digest first. Also, you do not need to be a pro. So to help navigate the options-trading world, I wanted to share two strategies with you that might make your trading journey less stressful and more profitable.
The first strategy is to use limit orders, which is something I do with almost all my trades. These can be a beautiful thing for both options and stocks. They help protect you on price, maximize profits while minimizing risk and make the mechanics of trading simpler to execute. I like to use day orders and Good ‘Till Canceled (GTC) orders. A day order will expire at the end of the trading day if it isn’t filled, while a GTC order remains open (the exact length varies by broker, but it’s usually 30 or 60 days).
Limit orders are also great because they help protect you against market specialists. These are members of the various exchanges who are essentially responsible for the trading in a stock or option. They usually hold inventory of the investment, post the bid and ask prices and manage the limit orders, and if they see a lot of market orders come into an option that isn’t commonly traded they will try to inflate the option price. These specialists are essentially shorting the option, so they’re looking to sell it at the highest price possible, which means they are going to try to make you pay more so they can make their money back. Limit orders force the specialist to give you the price you’re asking for.
The second strategy is rolling an option. This is very helpful when you’re up against expiration and need more time for the trade’s catalyst to play out. By rolling the initial option into a later expiration, you buy some time to either turn your position around or at least limit losses.
There are two steps to the process: selling the initial calls and then buying the newer ones with the later expiration date. Many brokers will let you do this in one transaction, which will save you a little bit on commissions. If your broker does not let you sell and buy in one transaction, that’s okay. You can still conduct the trade in separate transactions by selling your current calls and buying the ones with the lower strike price. I recommend contacting your broker if you have any questions on the correct procedure to execute a roll so that you’re all set for the next one.
And remember, when you roll a position, you are not adding more capital to the second position (that would essentially be doubling down, which I do not recommend doing in options trading). Instead, you’re simply rolling your remaining capital from the first position into the second.
I hope this helps get you more comfortable with options trading!