Trading options with OptionsXpress is as easy as pushing a button. All you need to do is pick a ticker and a strike price and push a button. However, that being said, trading options is a complicated task. Choosing a profitable trade takes knowledge, research, skill and a little luck. OptionsXpress provides all the tools any savvy trader will need to choose and trade options profitably. Included in the OptionsXpress toolbox are stock screeners, advanced charting, options pricers and streaming data so you have up to the second information on any stock/option combination. OptionsXpress also includes proprietary software that can help traders search for specific trades by strategy. The “StrategyScan” as it is called, searches the markets for specific strategies based on your trading level. Trades that you are not cleared for will not be included. I am level 3, so I can search for covered calls and puts, bullish call spreads, bearish put spreads or simply straight calls and puts.
So, to successfully trade options there are a couple of steps that any trader will follow. These include identifying the underlying trend, picking a stock, picking the proper options, risk management and placing the order. I will go into the basics of each step today with a more detailed description to follow.
Identifying the underlying trend is perhaps the most important step. Trading against the trend is the first no-no in stock speculation. Even stocks with bleak outlooks can rise in a strong market, negating any profits projected from a bearish trade. The same is true in reverse, strong stocks can be brought down by a bearish market. With this being said I'm sure you can see the importance of trading with the trend. To identify the trend I look to the major indexes; the Dow Jones Average (DIA), the Standard & Poors 500 (SPY) and the Nasdaq (QQQ). A quick look at the charts tells most of what I need to know. Is the market rising, falling or trending sideways. I check this in two time frames, short term or 1 year charts of daily data and long term, or 3 year charts of weekly data. This helps me see the waves and the ripples so I can plan my trades accordingly. While checking the charts I also look at the stochastic and MACD indicators for confirmation. Convergences and Divergences in these indicators are very telling signs of strength and weakness.
The next step is to screen for a good stock. Now, you can use the StrategyScan and let OptionsXpress pick possible trades for you, or you can use the stock screener and pick your own. I prefer to pick my own because the StrategyScan will list all possibilities without regard to some criteria I know from experience are important. With the screener you can choose stocks based on volume, price, p/e ratio, volatility, analyst ratings and Zacks industry/sector.
I prefer stocks with an average daily volume of at least 1 million shares. This tells me there is a sustainable interest in the stock and that it has sufficient liquidity. Lightly traded stocks may make the moves you predict but if you can't sell your position you will still lose. It is easy to see how necessary volume is. Once the screener results are up I check each chart for trend. Assuming the current trend is bullish, I look for stocks that are bullish. Out of the stocks that are bullish I check for high open interest. Open Interest is the number, or volume, of open option contracts and has the same meaning for the option as volume does for the stock.
The next step is choosing an option. Options are listed by expiration month and strike price. The expiration month tells you how long the option is good and the strike tells you at which price you have the “option” to buy or sell stock. I compare the projected stock move to the different strikes available, the strikes that expire before the stock movement is completed or that are too far out-of-the-money won't be profitable. For example, if you think Ford (F) is going to move from $12.50 to $15 in the next four months it would not be appropriate to pick an option that expires in two months or a strike above $15.
Now that you've picked a stock with high volume and open interest and chosen an appropriate strike price it is time to apply some risk management to your intended trade. Stock speculation, especially options trading is inherently risky. Even with appropriate due diligence there is no guarantee the trade will perform as expected. Risk management helps to ensure that no one trade, or series of bad trades, can wash you out of the market. For most traders, 2% account risk is acceptable. Some choose less, some more depending on account objectives. For me, I choose 2% account risk and 30% per trade. What this means for my account is this. If my account is worth $10k, I only want to risk $200 per trade. Since I set my stop-losses at 30% of cost, this means I can enter a trade for a maximum cost of $667. This number, divided by the strike price, tells me how many contracts to buy. If each contract sells for $300, and my account risk is $200, then I can buy two contracts. For example, 2 x $300 is $600. I will set my stop loss to sell the options if they decline by $90 each ($90=$300 x 30%, 2 x $90=$180). With risk management in place I will never lose more than the 2% I have allowed myself. I also know that I average a 50% gain per winning trade, so I set another order to sell the options when a 50% gain is reached. On average, if I win half and lose half I will be a net winner because +50%-30% leaves a gain of +20%, I am sure you can see the sense in that.
The final step, once direction, stock and strike are chosen is to set the order. OptionsXpress allows for highly detailed orders to be placed. I always set my orders to buy with contingent orders for “one cancels other”. What this means is I set the buy order for 2 options at $300. Once this order executes a contingent order for one cancels-the-other is automatically set in place. These two orders include my stop loss for 30% of the trade (no more than 2% of account value) and a limit order for a 50% gain of option value. It is important to set these so that one cancels the other, or else you may find yourself involved in a trade you had no intention of making. Another bonus of these contingent orders is that you won't have to make any knee-jerk decisions, you have already place the orders you know to be right for your account. Now all you do is sit back and enjoy yourself knowing your trade is in place and your account is safe.
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