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Ingredients for Opening a Position

4/7/2017

5 Comments

 
Though it's tempting we cannot blindly enter the market. It's important to keep these factors in mind when opening a position:
  • High liquidity- Options with higher liquidity have more accurate probabilities compared to those that do not. In addition, they are also easier to get in and out of.  If there's ever an anomaly in price or price being 'mispriced', millions of trades would immediately counter the trade and price brought back in line.  
  • Stock and Option Volume- Volume refers to the amount of contracts floating through the market at a given period of time. By assessing stock volume, we can automatically gauge options volume because options are derivatives of stocks. When entering we want a high volume. As a typical rule of thumb, we look for stocks with average daily volume of 1M+. In terms of options we look for open interest of over 1000.
  • Bid-Ask Spread- The bid-ask spread will allow us to determine the prices we will likely have to enter and exit with.  Typically, we ought to look for stocks that trade with bid-ask spreads of nickels or options with bid-ask spread of couple pennies.  For a frequent or active trader, these pennies add up. Given up a spread of a nickel on a $1 option is giving away 5% edge.
  • Portfolio Fit- Be aware of how your position fits your overall portfolio. If you a going long a position, be aware of the positive (or negative in some cases) deltas that it'll add to your portfolio. Don't ever trade based on someone else's trade. Some cases will report that over 1000 calls were bought in a particular stock. While this does soundlike being bullish on a stock, it could be just that someone is short on a stock and are hedging a bad position.
  • Size- This ingredient is as important as salt is to cooking. When you open a position, the only thing you can control is the size. You can't control as to how the stock will move, but you can control as to how this particular underlying will affect your portfolio by controlling the size. I try to follow TastyTrade's mantra of trade small, trade often. 
5 Comments

    Nisha

    Ninteen year-old trader,  future connoisseur of options.

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