I don’t normally do this with my options trades. Normally I’m looking for more significant moves over the course of days, or maybe weeks. But one of the reasons that I love SPY for Options trades is that the potential reward is great for relatively small moves. I recently calculated while watching that SPY could move less than 1/4 of 1% (0.2%) and if you picked correctly on your option then you can make a 30%+ profit right away.
So today I told myself, okay, lets try that out. Lets do some really quick day trades with relatively tight trailing stops and see what happens. Just for this trial I started with a small amount of money ($130) which was determined mostly because one of the options I was looking at with was around $1.30. I placed a total of 12 trades (6 round trips) and used trailing stops of 0.20. Some of my trades stopped out pretty quick, while others went for a while for good gains. My very first trade had a trailing stop of 0.15 and I felt it stopped out too quickly for a small profit so I adjusted to 0.20.
At the end of the day I had $196 out of the original $130 which is an overall return for the day of around 51% (50.77%). I may try this again some time soon and if it keeps working I may do it with more money.
The key to this strategy is to correctly use stops. I made myself put the stops in right away before I knew what was happening. Don’t watch it first and try to use your brain to make decisions because you will be wrong most of the time. The most successful traders use such a strict system.
Yes, you want to think about it before you place your entry, and strive to have the best entries that you can. However, no matter how talented you might be in judging the near term direction and ideal entry points, what matters more is the strict discipline of your system. Traders who have a strict system to limit losses do better than traders who have excellent stock knowledge but use a loose system. Traders who just randomly place trades without even looking, but follow a strict loss prevention strategy do better than traders who are stock experts but who do not use hard stops preferring to use their intuition.
The thing is, if you strive to day trade where you place many trades in the same day, the movement of the stock prices is actually pretty random. Nothing that you or the market thinks about fundamental factors of the company or even the economy has any meaning. The only thing that matters is that you buy low and sell high and limit your losses when the market is moving against you. When I put in my 0.20 trailing stop on option prices then the most I can lose is 10% or 20% if I’m wrong, but If I’m right I can gain 30%, 50% or 100%, or more.
Lastly, when I talk about loss prevention on options trades, I am generally speaking of straight buys of calls and puts. There are more complicated options strategies that already account for variable results such as the options strangle that I often use where you don’t really care which way it goes because either way makes you money. Yes, you can lose money on a strangle if the prices do not move at all, but there is really no way to set a stop for this.