The stock market has not been very volatile over the
past few months. True, it has made some decent one day
moves, but they are not repeated and they have been in
opposite directions. Unless your timing was
outstanding, it has been difficult to make money as
either a bull or a bear.
When you trade stocks, the best you can do is own the
best stocks based on value and anticipated growth. If
you are talented in finding good opportunities, you can
earn money in markets such as these.
When using option strategies, a trader can proper when
the markets move within a range. The big question is:
How long will this situation last and what are the risks
and rewards of making a play that depends on just how
large that trading range will be.
Betting that this range -bound market will end soon
A trader can buy puts and calls, and hope for a gigantic
move. This type of play often loses, but the
possibility of large rewards makes this a tempting
choice. We all know this stagnant market cannot last
forever, but options have a limited lifetime, and if you
make this play, the market must move fairly soon, or
else you incur a loss.
Another way to play for a big breakout is to buy put and
call spreads. Choose out of the money spreads that
don't cost too much, but which are not so far out of the
money that there is no chance you will collect. This is
a difficult play to make because the most likely result
is the loss of every penny invested.
The other side
On the other hand, you can take the opposite approach
and sell puts and calls (sell straddles or strangles) or
sell those put and call spreads (iron condor). The
trader's chances of success are much higher with this
approach, but the potential loss is larger than the
potential gain, and many conservative traders will not
touch these plays.
Knowing that most investment clubs tend to be on the
conservative side, the purpose of this post is to be
certain that you are aware of these plays - if you
choose to make one. The important risk management
factor is trading an appropriate number of spreads.
Calculate the maximum possible loss from the iron condor
trade, or estimate the loss potential when selling
strangles, and then decide how many options you can
afford to trade. Do not allow a large loss to damage
your account. It's okay to make one of these
market-neutral plays when the odds are on your side and
the maximum loss is small.
Mark D Wolfinger
Expiring Monthly: The Option Traders Journal