Are you ready to get back on track with trading options in 2024?
Or maybe you’re an experienced trader that wants to revisit some basic concepts?
You may already know some options trading mistakes you should avoid, but what about things you can do to increase the probability of being consistently profitable while trading options?
Read on to find out the top tips for trading options profitably in 2024!
Hedge Your Positions During Good Times
Just as Warren Buffett says, “Be greedy when others are fearful and fearful when others are greedy.”
In 2023, the stock market was up ~20%.
It’s highly unlikely that 2024 will be as strong.
Especially during periods of low volatility, when VIX is low, traders can hedge their positions by purchasing portfolio insurance for a pennies; often resulting in major gains during bear market crashes and pullbacks.
Make sure your trades are small. As an options trader, it may be tempting to use all your buying power, especially when trading naked options.
Using all your buying power is an extremely risky approach.
Before you know it, a few bad trades can wipe out months of profits.
Since options use significantly less buying power when compared to buying shares of the underlying security, the general tendency is to overtrade and trade more contracts than you should.
By doing this, you’re increasing your risk of being placed into a margin call if the trade does not go your way.
Would you like more tips on how to trade options profitably in 2022?
As an options trader, you should choose high quality, liquid, securities and make sure the spread between the bid and ask is small.
The illiquidity of your stock options can affect the profitability of your trading strategy because there may be significant slippage when trading and it may be difficult to roll / manage an illiquid underlying.
The true power of options lies in its leverage, flexibility and control to set up positions so that you create a high probability of profit.
Do you want to learn one of the best option trading strategies?
In the United States, Regulation T is available for accounts that have a minimum balance of $2,000.
When you sell naked options using Regulation T, it will reduce your available buying power by around 12% to 20%..
For example, if you sell one contract with a strike price of $100 it means that the notional value of that contract is $10,000 (since 1 contract is 100 shares).
If you’re trading Regulation T, then your buying power reduction is going to be anywhere from 12% – 20% of $10,000.
This means that your buying power will be reduced by $1,200 to $2,000 for every contract that you sell.
What is Portfolio Margin?
In contrast, Portfolio Margin is usually available to accounts with an account balance, or net liquidation value, of around $125,000 or more.
Overall, Portfolio Margin is more capital efficient than Regulation T and your buying power will be reduced by around 4% to 10% of the maximum loss.
Portfolio margin stress tests your entire portfolio in aggregate.
As a result, the further out of the money options that you sell, the less your buying power is going to be reduced.
This means that “PM”, or portfolio margin, looks at the risk of your entire portfolio.
Why should you use Portfolio Margin?
In my opinion, if you have an account balance of over $125,000 (the amount varies for each brokerage) then I believe it’s best to always use portfolio margin.
Tastyworks, E*Trade, Schwab and Interactive Brokers all offer portfolio margin for accounts over $125,000 – $175,000.
Portfolio margin works very well, especially when you’re disciplined, because it enables you to sell further out of the money options.
I remember when Amazon fell below $3,200 in late September 2021, during that time I sold put options on Amazon with a strike price of $2,200 or $2,300.
My buying power was only reduced by a few thousand dollars per contract, despite collecting around almost $1,000 for every contract that I sold..
Portfolio margin allows you to make less risky trades, and increase your win rate, without significantly reducing your available buying power.
You can sell further out of the money options and your trades will be more capital efficient when using portfolio margin.
Cons of Using Regulation T
Your premium collected as a percentage of buying power used is often significantly higher when using Regulation T.
Since Regulation T is less efficient, you may be encouraged to trade more aggressively and choose higher delta strikes so that you collect more premium.
This will lead to increased risk.
Major drawback of Portfolio Margin
One major drawback of using Portfolio Margin, particularly when trading naked options, is that during a large volatility expansion event, your excess liquidity tends to drastically decrease because many of your positions may get challenged at once.
As a result, it’s very important to make sure that you don’t trade too large and that you always leave an ample safety net.
If you trade too large, then you may be forced to close out your positions at an inopportune time.
As a result, you always want to ensure that you leave enough buying power to ensure that your portfolio can withstand a volatility expansion event.
Portfolio Margin allows you to take less risk by selling options farther OTM and still collect decent premium, without incurring a large decrease in your available buying power.
Oftentimes, even during periods of low volatility, traders can extend the duration of a trade, while going farther OTM, and make a trade using Portfolio Margin that wouldn’t be nearly as efficient if they made the same trade using Regulation T.
Also, Portfolio Margin allows traders to sell naked options much more efficiently than if they were using regulation T.
When people ask this question, they fail to understand that most human beings, at their core, act irrationally.
People are self-destructive. If they weren’t, nightclubs, cigarettes, casinos, lotteries, packaged foods, sodas, and other harmful stuff would not exist.
Human beings are a slave to dopamine, and this is getting worse with the advent of mobile devices, Instagram, TikTok, and similar things that provide people with instant gratification.
Because people are slaves to dopamine, they engage in short-term, risky behavior to get a dopamine fix. They do this because the consequences of their negative behavior are not immediate.
David Jaffee understands how difficult it can be to sacrifice.
David Jaffee grew up in a poor area and went to a high school where students did not have to work hard. David Jaffee often skipped class while still managing to get good grades and get into a good university.
However, when he went to Cornell, David Jaffee realized that his fellow students were very smart, and he had to study hard to keep up with them.
David Jaffee disliked attending Cornell University. Even though he received good grades, he was not as smart as the grades that he achieved. As a result, he had to outperform, out study, and out work the students that he got better grades than.
When he graduated college, David Jaffee started working as an investment banker, which was also extremely self-destructive. Nobody who actually cares about themselves should ever tolerate working in a toxic environment like investment banking.
Investment banking is a horrible job. Even the managing directors, most of whom have been working in investment banking for over 10 years, oftentimes hate their lives and possess a lot of self-loathing.
David Jaffee shares this experience because it highlights a bit of a paradox in thinking. Just because someone makes a lot of money or holds a position with a significant amount of prestige does not mean they are any better at engaging in self-destructive behavior than a typical person.
Many people who have achieved a large amount of success have had to make significant sacrifices that many other people would be unwilling to make.
Whether you’re a managing director or you’re unemployed, the point is that people are irrational.
Being a managing director at an investment bank is not a rational decision because you’ve had to sacrifice 10 to 20 years of your life in order to accomplish that goal.
Remember that we are slaves to dopamine. Not everyone is going to act rationally and start selling options.
The best thing to do is not to take any shortcuts and try to behave in a manner that sets your future self up for the highest probability of success.
Don’t act with a short-term focus. Instead, always try to keep your long-term goals in focus and behave in that manner. By doing that, you should be able to consistently earn about 3% per month by selling option premium.
Don’t try to hit home runs and don’t try to day trade or trade Forex and engage in risky behavior.
Instead, do what many other people are unable to do.
Think of your long-term self and then work your way backwards. To figure out how to be somewhere long-term, consider what immediate steps you can take today to accomplish your goal.
Some additional reasons why everyone won’t start selling options is that if everyone started selling options then options prices would become significantly undervalued and it would actually make sense to buy options!
If options prices were low, then the expected volatility would be less than the actual volatility, and you could profit from buying options!
Additionally, there will always be people buying, and selling, options as part of vertical credit spreads.
Learn more from David Jaffee by visiting BestStockStrategy.com. Enter your email to receive $400 worth of valuable options trading training materials.
However, while this topic is best for experienced traders, David Jaffee is sharing his knowledge on the biggest problem with selling options to help better prepare you for trading options.
David Jaffee has found that the biggest problem when selling options is that you really shouldn’t trade at all when many other people are making money.
The reason for this is that when many other people are making money, there is generally a sense of complacency in the market and the market tends to be going up.
As a result, volatility is really low. During periods of low volatility, the amount of money that you are going to collect when selling options is also going to be extremely low.
This can make it very difficult to sell options, and collect a little bit of premium, when the market is going up every single day because you would make more money by being long stock.
The problem with this thinking is that when you sell options you’re able to make money when the market goes up, when the market is flat, and when the market goes down.
However, when you are long stock, the only way that you’re able to make money is when the market is going up.
When the market is going up, and you’re collecting a small amount of premium, you may inherently feel that you’re missing out..
As a result, during periods of low volatility, many traders have a tendency to trade too large in order to compensate for the lower amount of premium that they are going to collect.
However, this is a very bad trading strategy.
In September of 2021 we experienced two or three days where the VIX increased by around 50%. During those days, your existing positions are going to show you a loss.
If you start trading really large when the VIX is low, during periods when the VIX is trading at about 15, then the VIX can double in price and trade to about 25 or 30 in one or two days.
If the VIX expands to 25 or 30, then almost all of your existing positions are going to end up showing you a loss and you’re going to allocate capital towards defending those positions instead of opening up new positions.
The biggest problem when trading options is that you are going to be tempted to trade often and trade large during the exact time when you should not be trading large and trading often.
The reason for this is that during periods of complacency, long stockholders are going to be making money and the market is going to be going up and hitting new highs.
You are not going to want to feel like you’re missing out. As a result, you’re going to be trading larger, which is precisely the wrong thing to do when volatility is low.
As of October 25th, the VIX was trading at about 15 and the market was relatively close to its 52-week high.
So what’s the solution? What is the best way to keep up with the market and to make a lot of money?
The answer is to be disciplined and patient.
David Jaffee recommends trading small and taking advantage of a few outlier moves such as PayPal, which was recently down around 40%, Facebook, which was also down around 20%, and Amazon, which was about 10% or 15% off its 52-week high.
Besides those three underlyings, and potentially Intel as well, David Jaffee says the best thing to do is to trade relatively small, especially considering that the VIX is trading around 15.
You have to accept that during periods of low volatility when complacency is high, you have to train yourself to not give into the temptation to keep up with people who are utilizing different trading strategies.
Remember that during times when the market is flat or during times when the market is going down, you are probably going to significantly outperform them. The only time that they’re going to outperform you is when the market is relatively euphoric and it’s constantly hitting new highs and volatility is extremely low.
During those time periods, you, as an option seller, should not be trading very often and you definitely should not be trading a large number of contracts.
David Jaffee recommends training yourself to be disciplined and not trade much during times of low volatility. You have to remind yourself that your time will come, and it will.
As Jim Rohn once said, “We must all suffer from one of two pains: the pain of discipline or the pain of regret. The difference is discipline weighs ounces while regret weighs tons.”
If you train yourself to be disciplined, you should be able to achieve annual returns of about 35% to 40% a year.
Learn more about selling options and practicing discipline with trading by visiting BestStockStrategy.com.
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