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Trading Rules, Tips, and Techniques

Buy intrinsic value and sell time value, whenever doing so is consistent with your outlook for the stock.

Buy low volatility, sell high volatility.

Buy more time, sell less time.

Simple is better. There are many option positions you could construct that look like they might have some merit. Always compare an "exotic" strategy to just buying a call or put, or using a vertical or calendar. You will usually find that the exotic position has no real benefit, and probably will be difficult and expensive to enter and exit.

Be extra careful if you find a situation that seems to guarantee a great return. They are often the same situations that have large losses, even the possibility of unlimited loss, if you are wrong.

Track volatility. Most stock investors get in the habit of tracking price action with various indicators in order to make buying decisions. Options strategies can profit from more than just stock price movement. Many strategies benefit from the implied volatility rising or falling, and you can track the volatility to make strategy decisions. You can either keep records of the IV of a stock, or you can keep records showing what a strategy costs to enter from one day to the next. For instance, the Ratio Calendar Call benefits from a rise in volatility after you enter it, which means you want to enter it when volatility is low. You could keep records showing what the cost of entry for a Ratio Calendar Call is every day, and buy it (as long as you are still bullish) when it is less expensive, which shows the IV is in a low range.

Don't enter positions at the opening bell, and especially not with market orders. You are not likely to get the best fill. Wait until the market sorts itself out and then use limit orders to enter.

If you want to exit a position, try using limit bids or asks that you think have no chance of getting filled, at the market open. There might be someone out there desperate to get filled for some reason, and you might get a better than normal price.

If you want to be successful over a long period of time, keep your risk on each trade very low: 1-2% of your account size. Any more than that and you risk digging yourself into a hole if you have a few bad trades in a row. If you are successful, increase your risk slightly. If you are going through a rough patch, lower your risk even more.

Ignore anybody that makes claims such as "$33,000 to $10 Million in just 18 months!". Even if true, it means they risked everything they had, several times. You'll never hear about the other 10,000 traders that went broke trying to do the same thing. And if the promoters could do it consistently themselves, why are they telling you about it?

Learn about The Greeks. Even if it all seems impenetrable at first, what The Greeks represent is important to option trading. On this site, we try to present The Option Greeks in a more practical way than some other information you may come across. Give it a try.

If you can't get full value for a long call on expiration day, you can short the stock, and exercise the long call. That way you get the full value between the long strike and the price you shorted at. For example, you are long a 30 strike call on expiration day. The stock is at $31.00 but you can't find a buyer for your call anywhere near what you "should" get: $1.00. Short the stock at $31.00, which brings in $3100.00. Exercise the call, which means you buy the stock at $30, a $3000 debit. Now your long stock cancels the short stock and you are left with $100, less commissions. Call your broker and ask for a "same day exercise" if you want to do this.

Sometimes after expiration, some brokers do not cross trades like the one just mentioned automatically. You might end up long and short 100 shares of the stock. You shouldn't have to try to trade your way out of the positions. Just call your broker and tell them you don't want the positions, and they should be able to make a bookkeeping entry that makes them go away.

The same thing can happen with an ITM bull call that you don't trade out of. For instance, you had a 30-35 bull call, and the stock was at 36 at expiration. Since the long call is in-the-money, you get automatically exercised and buy the stock at 30. Since the short call is in-the-money also, you get automatically assigned and end up short the stock at 35. If your broker doesn't get rid of the "long and short at the same time" position, call them up.

If you are ever long a put at expiration, and the put is in-the-money but you can't find anybody to buy the put at a reasonable price, you can buy the stock and exercise the put. For example, you are long a 30 strike put on expiration day. The stock is at $29.00 but you can't find a buyer for your put anywhere near what you "should" get: $1.00. Buy the stock at $29.00, which costs $2900.00. Exercise the put, which means you sell the stock at $30, a $3000 credit. The two transactions leave you with no position, but a $100 gain, less commissions. Call your broker and ask for a "same day exercise" if you want to do this.

You can trade bull call spreads in an account that does not have permission for spread trading, such as an IRA account, as long as you own the stock, and have permission to sell covered calls and buy long calls. For instance, you own 1000 shares of XYZ with the stock at 30. You can buy ten XYZ 30 long calls and sell ten XYZ 35 short calls. As far as your broker is concerned, you have ten covered calls and ten long calls, both allowable. As far as you are concerned, you have a bull call spread which will benefit if the stock moves up from 30, as well as shares of stock which will also benefit, of course. If the stock happens to rise over 35 and you do not want to lose the stock, you should close out the spread, otherwise you risk being called out of your stock.

You can also use the above idea to trade bear call spreads or calendar spreads if you want. Your broker still just sees covered calls and long calls.

You can sell puts (a bullish strategy) in an account that does not have permission for naked options, such as an IRA, by getting permission for "CSEP" trading from your broker. CSEP stands for Cash Secured Equity Put, and means that you can sell puts IF you maintain cash in your account to cover the purchase price of the stock if you are assigned on the short put. It is then up to you whether you use the short puts just for short term trades, or ever allow yourself to be assigned on a short put.

Since you can sell puts with the above strategy, you can also trade bear put or bull put spreads. Your broker will see a CSEP and a long put, both allowable. You can set up the combination as a bear put or bull put depending on your outlook for the stock, with the appropriate risk:reward and exit strategies.

In a similar manner, selling naked calls (a bearish strategy) is not allowed in an IRA, but selling covered calls is. As long as you own the stock, you can sell calls against it. It is up to you whether you approach the trading as opportunistic option day-trading or more normal covered call selling. Your broker won't care as long as the short calls are covered by stock. No matter how you approach it, you must buy the short calls back if the stock ever goes over the strike price you sold, if you don't want to risk being called out of the stock.

It is possible for a broker's automatic "matching" system to create an option margin requirement on your account that shouldn't exist. Sometimes this doesn't make any difference, but if you are close to getting a margin call anyway, the mismatch might cause a "false call". You should call your broker and ask them to either manually match your option positions, or put a notice on your account about the false call. For example, you own 1000 shares of XYZ, sell ten covered calls at the 20 strike, and also sell ten calls at the 25 strike, and buy ten long calls at the 25 strike to make a calendar. Your broker should match the short 20 strike against stock, and the short and long 25 strikes against each other, causing no margin requirement. But their automatic system might match the short 25 strike against the stock, and the short 20 strike against the long 25 strike (making a diagonal bear call), leaving you with a 10 contract x $5 x 100 shares per contract = $5,000 margin requirement.


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