Taking Smart Risk – Option Trading

The equity markets are a tricky game.  That being said, options are even trickier, considering you not only have to get the direction right but also the timing.  Some claim option trading is pure gambling, the type where degenerates who long for action cannot get away from the game until they go totally bust.  Well, it CAN be like that – if you let it control you.  Or, you can take another path, taking smarter risk and putting the odds in your favor.

There is some speculation and risk in investing, but the great luxury is having time on your side.  For option traders, that element is not always a friend.  As a buyer of option premium (calls or puts), I look to the charts first to find the names that will carry the most acceleration, speed, velocity and momentum in the short term.  Over the years I have recognized patterns that repeat over and over again with regularity, so my comfort level is pretty strong.  However, patterns are known to change on a dime and I must remain flexible to changes.  At times, trading will require being a bit smarter than the rest of the crowd.

So, taking risk is the name of the game, but we don’t just want to throw caution into the wind.  How can we make smarter decisions with respect to risk?  As usual, we have to know our risk tolerance level.  I’ve been known to have a high tolerance for pain (short term) as it relates to trading.  In other words, I can sit with a loss far longer than anyone could imagine – IF and only IF the chart/technical pattern has not changed.  But what is taking ‘smart risk’?  While there are no locks or guarantees in trading we can put ourselves in a better position to gain a nice return.  With option trading, the leverage is the gamechanger.  So, taking a smarter or more practical approach to risk can be quite beneficial.

For instance, taking some more time or buying a strike deeper in the money may enable you to stay with a trade longer.  Selling a call or a put can take down initial risk substantially, or perhaps hedging a stock position by collaring with options reduces risk.  There are many more trades to control risk, but the key is there are many different options, and maintaining flexibility and always looking to ‘move your feet’ allows you the freedom to take the gamble out of the game.

  • None

    Nice little article. I also love trading options but you do have a high risk tolerance. As the article states the trick is timing and sticking with your ideas as long as technicals support them. Once technicals break I’m out of a trade if I’m up or down.