WHY should a trader learn to do more than one options trading strategy? In today’s trading environment, it’s important to have more than just one arrow in your quiver.
The most familiar option play (other than speculatively buying a call or a put) is selling a covered call. There are a number of online trading workshops, sit-down seminars, books, videos and trading newsletters ALL geared to teaching this foundational trading strategy.
But when you really get right down to it, selling a covered call against stock that you own is a losing game except in a very specific market environment: sideways and somewhat volatile.
Each options strategy has a specific “signature”, a set of Conditions, Expectations, and Goals that set it apart as the most appropriate choice in any market condition…
So why is knowing the market’s signature” important? Well, doing the WRONG trading strategy for the market that you’re in may either limit your wins, or WORSE… it can increase your chances of losing. Let’s take the popular options trading play of selling a covered call. The signature of the covered call strategy looks like this:
Risk/Reward Graph for a Covered Call Trade
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See that? Looking to the right on this risk/reward graph, you’ll see that your possible gains are capped. That’s what that “flatline” is: the graph telling you that your profit taking potential is now dead. If you have a winning stock pick on your hands, and your stock shoots for the moon… TOO BAD if you sold a covered call. You don’t get to participate in that upside because you took a little money now to sell a winning stock to someone else at THEIR price.
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Here’s an even worse problem… what I call the “dark side” of selling covered calls. See, on the LEFT side of that risk/reward graph you see that there’s an almost unlimited potential for loss. If you own a stock… particularly if you own the VOLATILE kind of stock that have the sexier premiums… well, you also bear all the risk of a slide.
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Now, please don’t get the idea that I think covered call selling is for the birds. After all, I sell calls as well. It’s just that they are only ONE tool for ONE specific kind of market…and the market you are in might just not be the appropriate one for selling calls.
The best market for selling a covered call is when your stock is moving sideways but it’s been just bumpy enough to create some uncertainty. That uncertainty is built into the pricing of the options governed by this stock. In other words, volatility is pushing the premiums UP. When you sell a covered call in this environment, you’ll collect the most amount of premium… while at the same time having a good chance that you’ll keep your stock and can then do it again. These are the best Conditions under which to sell covered calls.
In a rapidly rising or rapidly falling market, however, YOU LOSE. Think about it… settling for a one month, 3-5% gain is false economy when you could have had a much higher gain by properly buying and holding. Amazon.com Inc. (AMZN) was trading at a high of $94.10 yesterday and right now is at $115.84. You’d feel like some kind of chump if you sold a $95 call yesterday, hmmm?
Even worse… having to hold onto a stock so you’ll have it “covering” your short call is bad news when that stock GAPS DOWN 30% overnight. Oh, that never happens nowadays? Look at the chart for DRIV two weeks ago (10/09/09) and what happened on the next day. Ouch. How comforting would it be to have picked up the 3% premium that a covered call would have generated? No thanks.
So what’s the answer? If selling covered calls only works in one specific sort of market, it makes sense to know how to RECOGNIZE that market when it does manifest.. and at the same time, learn what works in other markets. Because that’s what you’ll be dealing with most of the time.
At the RadioActive Trading Methodology Webinars (held most Tuesdays and Thursdays and FREE to the public) we’ll show current and historical trades that use as many as TEN different “Income Methods”… adjustments to an existing position… that generate cash, lower the risk, or both. Depending on market Conditions, we’ll show the most effective Income Method adjustments for some real-dollar situations.
During the RadioActive Trading Webinar we use a stock trade simulator to show the long term possibilities when you trade using reduced risk, unlimited upside instruments. These options trading strategies are applied in the right Conditions to minimize exposure and maximize return. Knowing TEN different “Income Methods”… ways to take money off of a stock without necessarily selling it… is quite empowering.
In “Why TEN Income Methods? Part 2”, I’ll be showing options trading systems that can take a position from low risk to NO risk, as well as positioning for unlimited upside potential. Look for another blog entry in the next two or three days.
I'm Kurt Frankenberg, and I have discovered how to truly put the odds on the side on the individual investor.
Hello Kurt,
First I want to say that in reading and listening to your info it makes a lot of sense and has now got me interesting in protecting and preserving my capitol while at the same time making some consistent, even if small, profit each month.
I am currenting reading “PROTECTIVE OPTIONS STRATEGIES” by Zerenner and Chupka. A REALLY good book that is changing the way I am going to trade in the future.
However, my biggest dilema in the game is figuring out why I should enter a specific trade in the first place. I notice that it rarely if ever happens that whoever I am watching or listening to at the time makes that info part of their presentation. Knowing the mechanics of options is necessary but what determines why you enter your trades?
Thanks a lot for the info that you do share.
Emmette Lang
Well, I suppose that you’re looking for a particular trading signal that I use to enter a trade. I’ll tell you that this is less important than the preparation and the plan.
Here’s what I mean: the two bywords, slogans, savvy sayings of RadioActive Trading:
1) Don’t pick stocks, pick STOPS!
and
2) Don’t time trades, trade TIME!
What these saying are meant to encapsulate are these precepts: 1) More importantly than conducting fundamental analysis, we want to LIMIT LOSS in the event that our stock doesn’t perform as expected and 2) During the life of the trade, we may make adjustments to the position AFTER it has manifested a direction. These adjustments lower risk, capture income, or both.
As to the actual signal that triggers the entry into a position: take your pick. I know that Mike and Ernie do RadioActive Trades, and I do too. Ernie likes to use Bollinger bands, last time we spoke anyway. Mike wants to see a stock go above its 50 day moving average. Me, I mainly look at the fundamentals (to the end of actually ignoring technical indicators) but I like to play the “cup and a handle” pattern sometimes…
Your personal entry triggers can be whatever you like. That isn’t the aim of what I teach in the webinars or even in my book, The Blueprint. What I do show is how to do the more important stuff, the parts that happen BEFORE and AFTER the entry: your homework on limiting risk and your adjustments to the position afterwards.
Since I’ve never found a 100% reliable entry, why would I teach one? Getting in is NOWHERE NEAR as important as getting out as a winner or at least relatively unscathed. That’s the focus of RT.
Hope this has been helpful, Emmette! Write anytime.
Kurt,
I’m a recent subscriber to PowerOpt.com and do not place a trade anymore without a married put. When I realized I could control the risk of every one of my trades, it was paradigm shifting for me. It was the final piece of my trading plan puzzle, so to speak.
I’d just like to say that I believe the answer to Emmette’s question is in part 2 of your slogan. IMO “time” is a critical component (if not the “Holy Grail”) of entering a trade. But not with respect to the put option. It has to do with the stock price itself.
Not to be coy, but If I gave you the answer I would be giving you something that, combined with what you sell, is just as valuable.
I hope I’ve piqued your curiosity. Would love to talk to you more about it.
Okay, I’m all ears 😉
Kurt,
Imo, the entry into a position (with a married put) should be made only on a recognizable chart pattern that has a base of longer duration than the protective put. In other words, (to exaggerate it) you shouldn’t make a long term (5 to 6 months) trade based on a 15 minute chart pattern.
I think this is a good idea. My put was 6 months out and cost too much for the 1 month trend pattern.