[Options] A Few Options Trading Rules of Thumb

Sean McLaughlin
August 23, 2018

Recently, an All Star Options subscriber wrote to me asking about some hard "rules" that I follow in entering and managing trades. The assumption was that I have some rules that I absolutely stick to which apply to every trade. As a guy who loves following rules when it comes to certain types of trading, I'm sorry to report that options trading isn't so cut-and-dried. There is nuance to position selection and management. It's much more art than science.

So while there are no one-size fits all answers to any questions about strategy selection, strike selection, and position management -- I've developed a few guidelines for myself that I rely on regularly as I ply my craft in the options market.

Here are some good rules of thumb that have served me well over the years, in no particular order:

  • When being a net buyer of premium (purchasing long options, purchasing vertical spreads, etc), I like to choose expirations beyond 50 days out. Once inside 21 days, theta drag really starts to become a problem for any long premium I have and I'll usually be looking to exit any open long premium trades at this time.
  • Conversely, when selling premium or income trades (selling naked options, short vertical spreads, Iron Condors, etc), the sweet spot to enter is when there is no more than 45-55 days until expiration. This gives us a chance to earn nice premium while putting us in position to capitalize from an accelerating theta decay.
  • When buying straight long calls or puts, I like to choose out-of-the-money nearest to (+/-) 25 delta strikes. It's a nice mix of affordability (bang for the buck) and opportunity to profit. When we're right, the leverage is a nice kick. When we're wrong, the loss doesn't hurt so much.
  • Conversely, when selling naked puts or calls (naked calls usually only as part of a short strangle), shorting 25 delta options gives me room to be wrong.
  • When doing calendar spreads, I like to choose the strike where I think prices are likely to stall (support or resistance) --- this gives me an opportunity to cover the short option cheaply and hopefully ride the back month long option to better prices later. Of course, if the underlying trades to my strikes before I've closed the short option, then I'll just close the entire spread and book the profit.
  • When selling Iron Condors, I often like to chose the 25 delta options for my short strikes and the 5 delta options for my long strikes. This results in an unbalanced Iron Condor where there is often more risk on one side of the trade than the other, but at trade initiation the deltas balance out to neutral which is where I want to be.

I expound on these topics and more in my latest episode of the Trading With @Chicagosean Podcast:

Hope this gives you some food for thought.

~ @chicagosean

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