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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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Michael C. Thomsett, author
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Thomsett Options
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Getting Started in Stock Investing and Trading
  • Options – 3 Ways To Resist Temptation 0 comments
    Apr 12, 2014 1:04 PM

    So many traders start out with a sensible plan, only to abandon it because of the way the markets move. This abandonment of a smart plan invariably leads to potentially small added gains but large added losses.

    In entering a trade, it is sensible to set two goals: the point where profits will be taken, and the bail-out point where losses will be cut. If you buy a long option, you should know going in that 75% of options expire worthless, so setting goals to sell and close make sense.

    For example, you buy a long option for 4 ($400) and set the following two goals: Sell when net value grows to 6 or above, representing a 50% profit; or sell when the value falls to 3 or below, a 25% loss. You know going in that time decay works against you, so you face the strong possibility of incurring losses from which recovery is unlikely. This means you have to select long options with some additional goals:

    1. Pick options at the downside swing. This means you enter the long position on sessions when the market drops dramatically. Stocks tend to follow the broader market, so when an otherwise well-managed quality stock falls several points, you know it is part of the index drop and not a factor of the company. This may be the best time to buy a call for a fast swing trade turnaround.

    2. Pick options at the upside swing. This suggestion does not contradict the one before. It is the opposite. Prices often rise just as irrationally as they fall. So when the index values jump sharply, stocks tend to go along for the ride; but you may see a retreat in the following two or three sessions. When the overall market prices rise quickly, but puts on the upside swing, anticipating a drop back to "normal" levels of trading.

    3. Know your stock beforehand. Every stock exhibits particular trading tendencies and rhythms. Some tend to over-react to broader markets while others hardly react at all. This tendency, called beta, is a valuable technical factor in identifying how stock prices react to market movement. Stocks may tend to exaggerate news as well. So for example, a disappointing earnings report of only a penny per share may cause the stock price to plunge, only to get back most of its decline in the following session or two. Knowing how a stock tends to act and react helps pick options with better market intelligence

    To gain more perspective on insights to trading observations and specific strategies, I hope you will join me at ThomsettOptions.com where I publish many additional articles. I also enter a regular series of daily trades and updates. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site at ThomsettOptions.com to learn more. You can take part in discussions among members on the site at the Members Forum.

    I also offer a monthly newsletter subscription if you are interested in a periodic update of news and information and a summary of performance in the virtual portfolio that I manage. Join at Newsletter - I look forward to having you as a subscriber. Please also check out my other site, ThomsettStocks.com

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