Ancient Chinese philosophers realized that with great danger often comes great opportunity. This nexus is further reinforced by the fact that the Chinese character representing both danger and opportunity is the same. Remember that only those who possess and use the necessary skills to survive the period of great danger are in position to profit from great opportunity. Risk control is paramount. - The extrinsic (time) component of the option premium goes to zero at options expiration. Always.
- Although statisticians would argue, the probability of occurrence of an extremely unlikely event is much greater if you “bet the farm” on the event not occurring. Never forget that black swans do exist.
- The human brain is not inherently logical. It evolved for survival and is prone to make erroneous assumptions and draw incorrect associations. To guard against these potentially costly errors, continuously challenge your assumptions.
- Absence of proof does not constitute proof of absence.
- Thinly traded options are usually characterized by egregious B/A spreads. You may be able to negotiate acceptable spreads to enter the trade. You will not be able to do so if you need to exit. It is usually better to stay away from these snares.
- Option orders executed as spreads always receive better fills than individually placed orders.
- Failure to consider current IV in an historic framework for the particular underlying will usually cost money.
- Failure to follow predicted changes in volatility prior to a known event (e.g. earnings) indicates there is some factor of which you know not. When discovered, it usually impacts your position negatively.
- Failure to use and understand option modeling and option modeling software puts you at a significant competitive disadvantage to other participants in the options market. The only thing more expensive than having appropriate tools is not having them.
- It is stunningly easy to “roll more than you can smoke”. It is usually disastrous to attempt to smoke all you rolled if you find yourself in these circumstances. This is another reason to model trades and crisply define risk.
- If you create multi-legged option beasts by manually entering the orders as opposed to entering from a graphical presentation, you will enter positions incorrectly and end up “upside down” and commit other similar errors more often than you thought possible. You must monitor the magnitude of extrinsic value when short options are ITM. Failure to do that and considering your trade plan in light of these developments, will result in unanticipated early assignment at the most inopportune times. Option positions can be easily adjusted to improve their structure only before they enter the ICU.
- Forgetting to honor time stops when holding certain varieties of option beasts can be as costly as forgetting price and/or P/L stops.
- Good traders know what they know; great traders also know what they don’t know. (more…)
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Ancient Chinese philosophers realized that with great danger often comes great opportunity. This nexus is further reinforced by the fact that the Chinese character representing both danger and opportunity is the same. Remember that only those who possess and use the necessary skills to survive the period of great danger are in position to profit from great opportunity. Risk control is paramount. Keys for Successful Traders
The biggest obstacle to successful trading is failing to recognize that losses are part of the game, and, further, that they must be accommodated. The perfect trading system that allows for only gains does not exist. Expecting, or even hoping for, perfection is a guarantee of failure. Trading is akin to batting in baseball. A player hitting .300 is good. A player hitting .400 is great. But even the great player fails to hit 60% of the time! Remember, you don’t have to be perfect to win in the markets. Practically speaking, this is why you also need an objective money management system.
It takes experience to succeed. Now, some people advocate “paper trading” as a learning tool. Paper trading is useful for testing methodologies, but it has no real value in learning about trading. In fact, it can be detrimental, because it imbues the novice with a false sense of security. “Knowing” that he has successfully paper-traded during the past six months, he believes that the next six months trading with real money will be no different. In fact, nothing could be farther from the truth. Why? Because the markets are not merely an intellectual exercise, they are an emotional one as well. Think about it, just because you are mechanically inclined and like to drive fast doesn’t mean you have the necessary skills to win the Daytona 500.