Option Strategy

It is quite different to trading options comparing to trading equity.

First, it behaves more likely as 2*, 3* ETFs but still even more drastically since it is 10* 100* to trade options. The option is a tradeoff between leverage and time. Leverage and the consequent positive Gamma are obviously beneficial to the option buyer. But the time decay always stands at the side of option writers. It is the case that 90 per cent of options will expire with intrinsic value 0. That is to say, most options will expire with zero value and option purchaser will surfer 100% loss and writer will gain 100%. While on the other hand, in the remaining 10 per cent cases option buyer will gain 1000%+ and writers will suffer that amount. It is a negative-sum game for the brave. It is quite normal for an option player to win 10000% one year while it could always happen in several minutes from 1 million to 0.

Second, never treat options like linear financial derivatives. It is not generally the case a call will raise with corresponding stock goes up. Implied volatility and time decay outweigh in some cases. For instance, a Feb AAPL call at 112 will lose its value even AAPL goes up from 105 to 110 in the last week of January. That is mainly because (1) Time decay is sharp and fatal for option buyer in the last month and particularly in the last two weeks. Do not purchase a lot of naked options near the expiration date because you will suffer a lot of time decay. (2) AAPL’s implies volatility before the ER is at its peak and after ER the implied volatility (the uncertainty) will goes down dramatically, which is also fatal for option buyer. A wise trading strategy could be purchasing options 2 weeks before ER and closing the position 2 days before ER. It is a strategy to earn the uncertainty premium for ER/CC/Labor Department Announcement/FOMC interest rate decision. While writing an option before ER/CC and closing afterwards could be a profitable but challenging strategy. These are advanced option trading strategies but still quite popular among option veterans.

Option trading is certainly different from stock trading. (1) There is a famous saying “Cut the loss and let the profit run” in the stock market while in the option market the Bible is “Cut the profit and let the loss run for option buyers”. The reason is that option is an “average down” game while stock and future market are not. (2) It is a must that option players should do day trading while such strategy for stock traders is the same as suicide. We can avoid time decay without holding a long position by day trading. But in the stock market such strategy will only contribute transaction fee to the brokers.


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