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Should You Aim for 100% Gains?


Options can be risky, even very risky, but they don't have to be. There are a lot of myths and misconceptions about options trading. Here is one of them: you should aim for at least 100% gain in each option trade, otherwise it is not worth the risk. Is it true?

 

Here are some questions you should ask:

  1. In order to make the 100%, how much do you risk?
  2. How much of your capital do you allocate for those positions?
  3. How much time do you give the trade to develop?

 

The first two questions are directly related to position sizing.

 

Consider the 2% rule described in Dr. Alexander Elder's excellent book "Come Into My Trading Room". The 2% rule is to protect traders from any single terrible loss that can damage their accounts. With this rule traders risk only 2% of their capital on any single trades. This is for limiting loss to a small fraction of accounts.

 

If you adapt the 2% rule and the risk in your trade is 50%, then you can allocate 4% of your account for that trade. If your risk is only 20%, then you can allocate 10% to that trade.

 

So here is another question:

 

Which one is better - one 100% winner which risked 50% and took one week to achieve or seven 10% winners which risked 20% and took one day each?

 

If you followed the 2% rule and allocated 4% of your account to the first trade, it contributed 4% to your account. But you could allocate 10% to each of the seven 10% winners, so they contributed a full 7% to your account during the same week.

 

myths.jpg

 

Our trading strategy is based on consistent and steady gains with holding period of few days to few weeks. Those are not Home Runs, but most of our trades had very low risk, hence you could allocate 10-15% of your account to each trade. Make ten such trades each month with average return of 10% per trade, and your account is up 10% per month.

 

Here are some conclusions:

  • There is more than one way to trade options.
  • Position sizing is one of the most important elements of trading, especially options trading.
  • Few small winners achieved with low risk might be better that one big winner achieved with higher risk.

What is really important is not an occasional 500% winner, but an overall trading plan. What really matters is the return on the overall account. Next time someone tells you how he made 500% in an options trade, please ask him the following questions:

  • How many trades you make every month on average?
  • How much do you allocate per trade?
  • How much do you risk per trade?
  • How many trades do you have open on any given time?
  • What is the average duration of the trades?
  • What is your winning ratio and average return per trade?
  • What is an average monthly return on the whole account using your strategy?

If you learn to ask the right questions, you can avoid the hype and properly evaluate an options strategy in context of the overall portfolio return.

 

Want to learn more?

 

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Unfortunately, as much as I hate to say this, because I am , by far, a "net" option seller.

Assuming you are experienced, and know what you are doing, and , most important of all, you are only holding the option for around 1-2 days , or less...typically less than 1 day, long options can very often make 100%, 200% or more returns VERY quickly.

But it is a very tenuous thing. You have to be extremely disciplined, and, as I said, be in the position for a VERY short amount of time to avoid any time decay, just using the leverage of options to your advantage.

Yes, a $1.00 option can easily go to $2.00 within a normal intra-day move.

But, as a "go to" method for trading, I would highly recommend against it.

"Kid's, don't try this at home".

Do it very rarely and if/when it works, DO NOT allow it to get you to start thinking that this might just be a great, new path to go down.

Again, as much as I hate to say it, I have made more money , on the rare times that I have done this than all losses combined.

But, I almost never do it. It is not a viable trading methodology over the long run because what it is based on is not something that is mathematically reliable.

There are times when it is a good thing to do but, it does take many years of experience to know when it is one of those times.

It is like the legendary quote from Supreme Court Justice Potter Stewart in 1964..."I can't define it but, I know what it is when I see it!"

There are certain things that , after decades of observing the market, you just know. These are among the rare things that cannot be backtested because of the quote ("I can't define it...").

If you can't define it, you can't backtest it.

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Well, this is exactly my point. Can you sometimes make 100%, 200% or more on a single trade? Sure. But since those returns also come with much higher risk, your position sizing must be very small. You cannot build a strategy around those trades. Small part of your portfolio? Sure. Those must be considered speculative trades, unlike those consistent and proven strategies we are using at SteadyOptions. 

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