Comments on: Day Nine: Ten of the Biggest Mistakes in Option Trading http://www.fusioninvesting.com/2010/02/day-nine-ten-of-the-biggest-mistakes-in-option-trading/ Fusing Fundamental and Technical Analysis with lashings of Behavioural Finance. Investing in Australia and North America. Thu, 02 Feb 2012 06:57:27 +0000 hourly 1 http://wordpress.org/?v=3.2 By: Dean Morel http://www.fusioninvesting.com/2010/02/day-nine-ten-of-the-biggest-mistakes-in-option-trading/comment-page-1/#comment-1678 Dean Morel Wed, 17 Mar 2010 10:19:04 +0000 http://www.fusioninvesting.com/?p=4992#comment-1678 Hi Strike Out, good questions. What follows are my thoughts and no doubt others have differing opinions. First though let me say there is no right or wrong strategy in options, there are simply appropriate strategies that fit your personality and the outcomes you're seeking. <b>Selling lottery tickets</b> You almost covered the downside of this strategy with the second part of your question. If you keep selling options for a pittance one day surprise volatility will take away all (more or less) of your gains in one swoop. A classic Black Swan. Surprise volatility is one of more interesting strategies for call buyers. If you can stomach lots of small losses then buying those calls on the probability that one day you'll get a big pay off is an interesting strategy. If you like lots of small gains and don't mind a a big loss/missing a big gain then scalping those nickels may be for you. That takes me to <b>Buying lottery tickets</b>. I've found the option market to be more efficient than the share market. If there is expected volatility that will be priced into the options. e.g. earning call or FDA announcement. If you can stomach lots of small losses then that may be a worthwhile strategy. As most people are wired to take lots of small gains and to forget the occasional big loss then it is probable that strategy will be more profitable over the long run than scalping those nickels in the last week. The issue is can you really stomach all those small losses month after month after month. I couldn't. If you think you can then I'd love to know how it works out and what you discover. An tangential strategy may be buying calls on biotech stocks over the coming years. With many pharma companies needing to fill pipelines I consider it likely there will be heightened M&A is the sector this year. Hi Strike Out, good questions. What follows are my thoughts and no doubt others have differing opinions. First though let me say there is no right or wrong strategy in options, there are simply appropriate strategies that fit your personality and the outcomes you’re seeking.
Selling lottery tickets You almost covered the downside of this strategy with the second part of your question. If you keep selling options for a pittance one day surprise volatility will take away all (more or less) of your gains in one swoop. A classic Black Swan. Surprise volatility is one of more interesting strategies for call buyers. If you can stomach lots of small losses then buying those calls on the probability that one day you’ll get a big pay off is an interesting strategy. If you like lots of small gains and don’t mind a a big loss/missing a big gain then scalping those nickels may be for you.

That takes me to Buying lottery tickets. I’ve found the option market to be more efficient than the share market. If there is expected volatility that will be priced into the options. e.g. earning call or FDA announcement. If you can stomach lots of small losses then that may be a worthwhile strategy. As most people are wired to take lots of small gains and to forget the occasional big loss then it is probable that strategy will be more profitable over the long run than scalping those nickels in the last week. The issue is can you really stomach all those small losses month after month after month. I couldn’t.

If you think you can then I’d love to know how it works out and what you discover.

An tangential strategy may be buying calls on biotech stocks over the coming years. With many pharma companies needing to fill pipelines I consider it likely there will be heightened M&A is the sector this year.

]]> By: Strike Out http://www.fusioninvesting.com/2010/02/day-nine-ten-of-the-biggest-mistakes-in-option-trading/comment-page-1/#comment-1677 Strike Out Wed, 17 Mar 2010 07:12:22 +0000 http://www.fusioninvesting.com/?p=4992#comment-1677 What about the strategy of selling front month slightly OTM calls (covered) during options expiration week? Yes the premiums are usually pitiable since the contracts are only days away from expiring, but you can squeeze out a little money and you're only locked into the underlying for 5 days (or less). You always have options buyers chasing lottery tickets, even more so during expiraiton week, so why not take a bite here? And speaking of which, from an options buying (lottery ticket) perspective during options expiration week, what about gambling on volatile events that are scheduled to occur for several companies on the week of expiration? For example, many companies have earnings that come out the same week as options expiration, and in the event that there's a shocking earnings disappointment or surprise on top of the fact that expiration for contracts is days away, options buyers could find themselves with a major homerun should the underlying experience a huge move that same week. Since the options premiums have lost their time value and are days away from being worthless, it is possible in these particular circumstances for "just slightly" OTM calls/puts to go from cents to dollars in a day thanks to their looming expiration and the volatile event that caused the underlying to explode. Thoughts? What about the strategy of selling front month slightly OTM calls (covered) during options expiration week? Yes the premiums are usually pitiable since the contracts are only days away from expiring, but you can squeeze out a little money and you’re only locked into the underlying for 5 days (or less). You always have options buyers chasing lottery tickets, even more so during expiraiton week, so why not take a bite here?

And speaking of which, from an options buying (lottery ticket) perspective during options expiration week, what about gambling on volatile events that are scheduled to occur for several companies on the week of expiration? For example, many companies have earnings that come out the same week as options expiration, and in the event that there’s a shocking earnings disappointment or surprise on top of the fact that expiration for contracts is days away, options buyers could find themselves with a major homerun should the underlying experience a huge move that same week. Since the options premiums have lost their time value and are days away from being worthless, it is possible in these particular circumstances for “just slightly” OTM calls/puts to go from cents to dollars in a day thanks to their looming expiration and the volatile event that caused the underlying to explode.

Thoughts?

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