The FIRST Trading Strategy You Need To Master To Succeed At Options Trading!

Directional Options Trading most mirrors trading with stocks.

When the price goes up, you buy a stock position and then when it starts to go down, you sell it to make money.

The difference between trading stocks and trading options is you can also make money when the price is going down.

How can you make money when the price is going down? Well, the answer is you buy a Put when the price of the stock starts going down and then exit as the price starts going back up. It sounds pretty simple. And the mechanics of the trade ARE just that simple.

But the art of the trade is where you start seeing the extraordinary gains you want. That's what I'm sharing with you today - some of the art of the trade for those extraordinary gains.

Directional options trading is your first step to becoming a great options trader. Once you master these basic skills, you'll find more complex trading is easier simply because you understand the forces of work. So let's harness those forces step by step. The first step is finding stocks or tickers that are moving in a clear up and down pattern. I prefer smooth patterns without drama and the tickers I choose. There is a relationship between the price of the stock and the option cost and relationship has to deal with the volatility of the stock. The more unpredictable the price, the higher the volatility, and the harder it is to trade.

However, if the volatility is too low, you won't see the gain percentage as high as you want to see.
I prefer directional trading with an implied volatility of between 27 to 50%. I tend to get my best and most consistent returns in this area.

Calculating Implied Volatility For A Stock

How do you find out what the implied volatility is for each ticker you're considering?

Well, on most trading platforms, this is one of the criteria you can add to your option charts.

After choosing the best tickers to watch, the next step is to identify best entry points.

Best Entry And Exit Points

This is where Support and Resistance come into consideration when you buy a Call. Remember that you want the price to go up. So the best entry point is going to be when the price is at the support area and about to go up. For a Put trade you want the price to go down and the best place to place that Put trade is at resistance. So when the stock goes down, your option makes money. Next you have to choose both the strike to trade and the expiration period to trade in.

Choosing Expiration Period For A Trade

Let's start with the expiration period. Most of my directional trades last about a week, maybe seven to 10 days max. With that in mind, I don't want to go too far into the future. If I do, the price of the option will be much much higher and controlling the risk that far out is a little harder and you're forced to trade less contracts.

You also don't want to trade in an expiration period that is too close because of time decay. The minimum I will consider for my expiration period is about two weeks in the future. I prefer to trade 20-30 days in the future. It leads to less exposure of time decay, the option price is less and I can trade more contracts and make more money there.

Choosing The Strike To Trade

We've chosen our ticker to trade, we have the expiration period and next is choosing the strike to trade.
In directional options trading, there is a break factor called delta. The Delta is what the option price changes for that same movement. I like to trade my options at a Delta of about 50 which is right at the money. If you trade a higher delta, in the money, the price of the option is higher and to control the risk you have to trade less contracts.

Controlling Your Risk In Options Trading

So how do I calculate and control my risk? Well, first you have to decide how much you're willing to risk on any one trade. Are you willing to bet heavy and risk 50% on your portfolio total? I'm not. I usually set my limit between two to 5% of my total portfolio. That's all I want to risk on any one trade.

Let's say you have 25,000 in your portfolio, and you've decided to risk the 2 to 5%. That would mean you could only risk between $500 to $1,250 on any one trade. Sure it would hurt to lose that money but it isn't as bad as losing the $1000s of dollars more by not controlling that risk. What you are risking is the cost of the premium you buy the option for.

Directional Options Trading Example

Here's an example of how I'd set up a trade using all the elements we've just been talking about. Let's say you have $25,000 in your trading account to calculate the risk, it's $25,000 times 5% that would equal $2,500. And you're going to buy this option right at the money or the Delta 50 area. It's going to cost you $5.75 per share. Now there are 100 shares in each contract. So that means each contract will cost $575. If you divide that $575 into the $2500 risk, you can trade 4 contracts. Now, let's say the stock price moves $3 in your benefit. That means you could then sell that same strike for $7.40 making your overall profits $660.

Same scenario, but this time you decide to buy in the money delta and I want to show you the difference. Same $2,500. You buy it at $7.40 a share. That means $740 per contract divided into the 2500 means you could only trade 3 contracts to maintain the same risk. Stock was the same $3 to your benefit. You sell for $8.60 but your overall profit is only $360 .So you can see why I like to trade with more bang for my buck.

Well guys, now you have a basic understanding of directional options trading, I want you to try it out, and I'm going to suggest doing it in paper money for a while until you get the hang of it, then go to real money. This is just a small example of what we teach over at Investing Buddies. See you next week!