To The Moon

My Options Trading Strategy: A Detailed Guide (Part 1)

To clarify the strategy I shared in my recent Tiger Brokers interview, here is a more detailed breakdown of its application.

I categorize market movements into two primary scenarios, each with a corresponding strategy:

1. Directional Trend (Bullish or Bearish): When a stock shows a clear technical trend, I use a Bull Call Spread (for bullish outlooks) or a Bear Put Spread (for bearish outlooks).

2. Sideways/Neutral Movement: When a stock is trading within a range, I employ strategies like the Iron Condor or Credit Spread (Call/Put), which aim for a neutral to slightly bullish or bearish outcome.

Understanding the Bull Call Spread / Bear Put Spread

This is a two-legged options strategy. For a Bull Call Spread involves:

• Buying one call option/ put option.

• Selling one call option/put option of the same expiration date but with a higher strike price.

  Tradingview Options Chart Bull Call Spread

Tradingview Options Chart Bear Put Spread

The core benefit of this two-legged approach over a single option is that it is more capital-efficient for traders with smaller accounts. By selling the higher strike option, you collect a premium that partially offsets the cost of the one you bought, thereby reducing your net investment and defining your maximum risk.

Cost Comparison:

• Single Long Call: Buying 1 call contract at $22.86 would cost $2,286.

• Bull Call Spread: Buying the $22.86 call and selling a higher strike call for $22.51 results in a net cost of $35 ($0.35 x 100 shares).

Strategy Execution: Entry and Exit Points

Entry Criteria:

• Signal: A clear technical bullish or bearish signal on a stock.

• Implied Volatility (IV): Ideally, buy options when IV is below 40 (cheaper premium) and sell options when IV is above 40 (more expensive premium).

• Long Leg: Buy an In-the-Money (ITM) or At-the-Money (ATM) option with a delta greater than 50.

• Short Leg: Sell an Out-of-the-Money (OTM) option, typically one or two strikes away from the current price.

• Duration: Choose options with 30 to 60 Days to Expiration (DTE).

Exit Criteria:

• Unfavorable Move: Close the position if the price moves against your forecast or fails to reach the target before expiration.

• Preserve Capital: Always close the trade to capture any remaining time value, rather than letting the options expire worthless.

• Stop-Loss: Consider setting a stop-loss at 20-50% of the net premium paid for the spread.

• Key Principle: Remember that options have time value. If your trade isn't working, close it to salvage the remaining value and wait for the next opportunity.

Important Note:
Your primary enemy in this trade is Theta (time decay). If the stock price doesn't move as anticipated, the constant erosion of time value will diminish the worth of your position.

Bull Call Spread: Pros and Cons

Pros:

• Defined Gains: Allows for limited, predefined profits from an upward price move.

• Lower Cost: Cheaper than buying a naked call option, as the sold option reduces the net cost.

• Limited Risk: The maximum potential loss is capped at the initial net debit paid to enter the spread.

Cons:

• Capped Upside: You forfeit any profits if the asset's price rises above the strike price of the short (sold) call.

• Limited Profit Potential: Gains are restricted by the net cost of the premiums, even if the trade is successful.

Important Note on Options Price Movement:

Do not assume that if the stock price moves favorably, your option's value will move linearly. The relationship is non-linear due to Gamma.

• Delta estimates the option's price change for a $1 stock move.

• Gamma measures how much that Delta itself will change with the stock move. It represents the acceleration or curvature of your option's price.

In a Bull Call Spread:
As the stock rises and approaches the strike of your short call, the Delta of that short position increases rapidly (high Gamma). This causes your overall spread profit to increase at a slower rate, capping your gains even as the stock continues up. This is the intrinsic trade-off for the strategy's lower cost and defined risk.

Always remember: Gamma explains why option profits can decelerate or accelerate unexpectedly as the underlying moves.

Stay tuned for the follow-up article, where I’ll break down the Iron Condor and Credit Spread in detail. If you wish to watch my playback, kindly click this link: Nick: The Uni Kid with 1 Year Options Experience

Disclaimer

General Risk Warning:
Trading options involves substantial risk and is not suitable for every investor. The strategies discussed herein, including but not limited to Bull Call Spreads, Bear Put Spreads, Iron Condors, and Credit Spreads, carry the potential for significant losses. You should only engage in options trading if you fully understand the nature and extent of your exposure to risk.

No Financial Advice:
The information provided is for educational and informational purposes only and does not constitute financial, investment, or trading advice. It should not be interpreted as a recommendation or solicitation to buy, sell, or trade any security or financial instrument. The author is not a registered financial advisor, and the content reflects personal strategy and opinion only.