When it comes to options trading, picking the right option is crucial to achieving the outcomes you’re after. Let’s break down some of the key factors to consider, from understanding expiration dates to managing risk.
1. Choosing the Right Expiration Date
When selecting an option, your first consideration is the expiration date. Typically, I look at options that expire within the next 30-90 days. The reason? I want enough time for my trade to play out, but I also don’t want to overpay for time I don’t need. If I’m working with a stock that has high volatility, I may lean toward shorter time frames, like 30 days, since I expect a quicker move.
2. Understanding Strike Prices
The next thing to consider is the strike price. I tend to favor strikes that are slightly in or slightly out of the money. Why? Because these strikes give me the best balance of price and potential payoff. For example, if the stock is trading at $50, I might choose a $52.50 or $55 strike if I’m bullish.
3. Assessing the Option Premium
Always take a close look at the premium you’re paying. Options come with time decay, so if you’re overpaying for time value, your option can lose value quickly even if the stock moves in your favor. That’s why I emphasize picking options with manageable premiums — you want to maximize your upside without losing too much on decay.
4. Managing Time Decay
Time decay, or “theta,” can work against you if you’re holding an option for too long without a move. A good rule of thumb is to monitor the option’s decay rate and set a timeline for when you expect the stock to move. If your option starts losing too much value from time decay, it may be time to cut your losses.
5. Using Scans to Find Opportunities
One tool I often use is high noon scans. This scan helps identify stocks that are showing unusual volume or volatility, which often indicates a potential move. Once I’ve identified a stock through these scans, I’ll dive deeper to decide if it’s a good candidate for an option play.
6. Determining Profit Targets
Before entering a trade, set a clear profit target. For example, if I’m in a call option with a target stock price of $75, I’ll plan to exit once it hits that level. It’s crucial to stick to your targets to avoid losing gains or being caught by unexpected market moves.
7. Knowing When to Exit
If you’re in an option that loses half its value, I recommend cutting your losses and moving on. Waiting for a recovery can often cost more than simply exiting and finding a better trade. Similarly, if your option hits the target, don’t hesitate to take your profit — greed can turn a winning trade into a loss.
