Option Spread Trading Is Not for Everyone
By: Billy Williams
More than twenty years ago when I was starting out as a trader, Futures Magazine ran an article that stated, “Pure directional option traders have great war stories about how they made a killing in the market but spread traders drive nicer cars.” While option spread trading can be very profitable, it is not for everyone.
If you love option trading or are considering engaging in option trading, there is nothing like the sheer thrill of catching a trend at the right time. Options have an enormous edge when it comes to leverage and limiting your risk to only the price of the option contract.
The frustrating thing about option trading is that occasionally you can make all the right moves and still lose money, because share price volatility worked against you. Options have incredible leverage and risk control. However, bad timing can make your options lose so much value by the time the move you predicted materializes that you end up at a loss anyway.
Once commission costs and the spread between the bid/ask price are taken into consideration, quite a few hurdles remain that must be cleared before making any money. So, what are the advantages of option spread trading that make it possible to overcome some of these challenges?
Option buyers typically carry more risk than option sellers because options are “wasting assets”, which means their value is tied to a definite period of time.
If you buy a long call option on a stock that trades sideways, or even declines in price, then your call option position is losing value, not just because the stock’s price action is going nowhere, but also because time is also eating away at the value.
This is why stories of traders making a fortune with options are fairly common. When things align correctly, it’s like winning a huge jackpot! However, huge windfalls are typically followed by huge losing streaks. What can you do to avoid this rollercoaster ride?
Spread traders use options to make the biggest weak link that common option traders face — time decay — work for them rather than against them. They do this by constructing low-risk option spread positions using proven option strategies combined with step-by-step trade setups. Used correctly, this places the odds in your favor, virtually locking in profits and helping you rack up a long string of winning trades.
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Directional traders need price movement in order to profit. Option spread traders don’t. If a stock trades flat, upwards, or even downwards, to a degree, the spread trader can still come out ahead. Those are three-to-one odds in your favor before you ever put on a spread trade. A proven system that helps you select the best trades can increase those odds of success even further.
You will miss out on some wildly successful and incredibly profitable trades at times by trading only a pure call or put option. However, you can achieve consistent profitability by using option spreads. These option trading strategies require some patience and study. The strategies are not very difficult to learn, but they are not for everyone and require a certain type of personality.
Spread trading strategy is not for you if you trade for thrills by swinging for the fences in every trade, if you have no regard for risk control and believe that the markets are a giant casino or if patience isn’t your strong trait. However, if you are a patient and disciplined investor, options spread trading could be a tool for steady profit.
If you held stocks or mutual funds over the past ten to fifteen years, you’ve experienced one of the worst periods of stock market investment returns in history. When the stock market bubble popped in early 1999, it destroyed trillions of dollars of investors’ capital and caused a ripple effect that was felt by every investor across the globe for the next thirteen years.
In the last decade or so, the stock market has been stuck in a giant trading range that has seen stocks trade up and down like a giant seesaw and left investors with the impression that the game is rigged, the table is tilted, and the stock market is little more than a giant casino.
The buy & hold strategy that served so many generations of investors in gaining financial independence has left a big question mark in the hearts of Main Street as to whether it works anymore. Now, many investors rightfully see the stock market as a giant casino that benefits only the insiders on Wall Street.
Since the dot-com era, another bubble has formed, this time in the housing industry, which came to a head in 2008 and almost took down the entire global financial system. Investors again saw their investments take another big hit when it was just starting to see a glimmer of hope of recovering from massive losses nine years earlier.
Even though these traditional investing strategies are highly susceptible to market volatility, there are ways in which spread trading can be used to achieve steady profit regardless of market direction.
About the Author: Billy Williams is a 20-year veteran trader specializing in online stock trading and options trading. He has been published in Futures Magazine, Traders.com Advantage, Stock & Commodities Magazine and StockInvestor.com