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What are the Best Options Strategies

By 18th June 2019 News No Comments

Spoiler: there is not.

Before writing this article, I thoroughly checked the title on Google as I wanted to make sure I was being original. Then, I stopped writing for an hour and could not even focus anymore.

I was horrified when I read on the first page of Google results what people consider to be the “best options strategy.”

 

Most of the advice I found was simply dangerous and, sooner or later, will lead to certain death of your portfolio.

The very first result comes from a website that clearly states: “the best options strategy… is selling a naked put on stocks.”

This is no different from saying, “the best way to drive a motorbike is without wearing a helmet, naked, and with the lights off.”

Being my reader and already experienced, I don’t have to explain why such a strategy, if done systematically over time, would lead to certain failure.

Consider the idea of going to a casino and playing roulette. If you play long enough, you’ll lose everything. Because betting on roulette has a negative expected value, losing everything is just a matter of time.

The naked put option strategy suggested on the first page of Google is much worse than roulette betting because it will lead to losing potentially much more than invested. It can really happen.

I was supposed to talk about something else in this short article, but I am still shocked by this terrible advice. However, if I can stop someone from following this silly Google advice, I will have done my good deed for the day.

It is time to explain now why there is no such thing as a best options strategy. It is instead more important to consider why people ask for it—why does everyone hope to find the path to easy money? In reality, there is only a best options strategy for a specific market condition and at a certain time.

A combination of bought and sold options cannot be good or bad per se if it is not related to a specific stock or future and market condition. A specific option combo (an iron condor, a naked call a spread, etc.) is just an instrument that permits you to transform a forecast into a profit.

If I asked a doctor for the best cure, I would not get a response. Similarly, if you ask me what the best strategy is (a very common question), I would avoid giving an answer in various ways, depending on my mood.

Making money in options trading is just a matter of making a forecast then taking a position in those options that would profit from the realization of the forecast.

Giving a name to a combination of options, as is done in most of the books for retail traders, will create useless and dangerous constraints in their minds.

For example: if I wanted to trade a credit put spread, and I also sell an OTM call option, but someone with completion bias has the temptation of buying an OTM call to make an iron condor.

When I teach options trading, or even when I have held options pricing guest lectures at the university, I never give a name to the combo of options I am using at that moment. This is because the strategy is in the forecast and not in the name of what I am using to implement it.

If I build the strategy piece by piece, it is much more likely that I am aware of the final risk I am running. In comparison, trading with prefabricated strategies is like eating very processed food—it is not easy to know what you are eating. For the same reason, if a beginner reads somewhere that a certain combo of options it is better, he will trade it without breaking it down into its smaller parts to gauge the risks.

 

I guess that the naming mania in options trading was born when the first books for traders came on the market. I build my trades option by option. I make a forecast then I buy or sell options, depending on which risk I want to run or which one I want to have hedged. I don’t think in terms of iron condor, strangle, batman, etc. I only think in terms of what is sold and what is bought. The final combinations usually have no name. But naming things is not exactly the first goal of a trader.

Last year, I was attending a conference in London that was organized by one of the biggest investment banks. A quant developer was giving a speech about volatility arbitrage; the math was very hard, so I understood what I could, considering it was 9 pm after drinks and dinner. A guy asked him if he could use a Batman and the speaker thought that the gentlemen have asked if the superhero could do something to help us with options. He responded, “I don’t think so.”

He is probably still wondering if he understood the question or not, or if there was simply a language misunderstanding.

If you want to know more check out our Option Trading Programme