There is always a bull market somewhere. Take prudent risk.
Being Profitable Trading Options
The Definition of Compounding: "The ability of an asset to generate earnings that are then reinvested and generate their own earnings."
Making interest on interest, the power of compounding interest is truly magical. At 15% interest for 25 years, $10,000 would grow to $330,000!"
As traders join us at OEX Options we often receive the key and age old question: "how much money can I make, or lose"?
The rules of profitable trading define the success of the trader, and this article helps define a profitable trading system for you - a geometric method to build profits.
The first mistake most traders make in options is trading too often, and repeating mistakes.
Here's a geometric approach to profitable option trading.
Define exactly how much you are investing in total.
Set specific profit goals over a defined period of time for that original investment.
Incrementally increase your exposure to the trading.
Let's assume 8 trades.
Trade #1-3 contracts at 2.00. Profit goals of .75 per contract, and a stop loss set of 1.40
600.00 outlay, 225.00 profit
Trade #2-4 contracts at 2.50. Profit goals of .75 per contract, and stop loss of 1.75
1000.00 outlay, 300.00 profit
Trade #3- 5 contracts at 3.00. Profit goals of .90 per contract, and stop loss of 2.10
1500.00 outlay. 450.00 profit
Trade #4- 6 contracts at 3.50. Profit goals of 1.05 per contract, and stop loss of 2.40
2100.00 outlay, 630.00 profit
We will assume you are profitable on the four trades you've made so far.
We also assumed all prices above include commissions paid, as we figure with all of our option positions.
In your four successful trades you've invested a total of $5200.00 and profited $1605.00
But it's option trading, so here comes our first bad day.
Trade #5- 7 contracts at 4.00. Profit goals of 1.00 per contract (lower as the option goes up in price). Stop loss of 2.80
As soon as you buy this option it moves down and you hit your stop loss, selling at 2.80, for a loss of 840.00
So, at the end of 5 trades you have a net profit of 690.00, and still have your original 5000.00
Trade #6- 10 contracts at 2.00. Profit goals of .75 per contract. Stop loss of 1.40.
2000.00 outlay. 750.00 profit.
Trade #7- 12 contracts at 2.50. Profit goals of .75 per contract. Stop loss of 1.75
You lose on this one. 900.00 down the tube
Trade #8- 15 contracts at 3.00. Profit goals of .90 per contract. Stop loss of 2.10
4500.00 outlay. 1350.00 profit.
At the end of 8 trades you have net profit of 1890.00. We've assumed 2 of the 8 trades were unprofitable, using a 75% accuracy ratio on our alerts.
What we've left out of this important scenario is that we began with small trades, built our number of contracts up, and began using margin dollars to make the trades.
As you begin to use margin your incremental opportunity increases, as does your risk. It allows you, however, to begin trading larger number of contracts, often more expensive at the money/in the money options.
What many traders do wrong with blue chip (or any) options is trading too frequently, and not building the value of the options they trade.
And many traders wrongly risk margin availability on building bad inventory, or they don't use margin as the money leveraging tool that it can be.
You'll note in our alerts that we often choose out of the money options while offering in the money higher priced closer strike point options.
This allows traders to define both risk management goals, and to trade either signal, based on the type of inventory they are building.
The geometric approach to profitable trading: Set a profit goal with your original investment and work the buying and selling of options to reach that goal. Have strict and tight stop losses. Increase your exposure incrementally using the profits from prior purchases.
Email us with your stock option trading questions: email@example.com