[Options] What About the Trades I DON’T Take?

Sean McLaughlin
February 1, 2022

I was chatting with an All Star Options member this morning and he asked me a very insightful question:

“Sean, I’d be very interested in your thoughts on why you choose not to make a trade in certain setups?”

He went on to elaborate that he’d like to know the things I look for that are possible “red flags” that prevent me from pulling the trigger in otherwise good stock setups.

The overwhelming majority of trades I put on for All Star Options subscribers are in stocks that the All Star Charts team has identified as stocks we want to be in (either long or short).

The most common reason I won’t pull the trigger is

because of liquidity issues with the options on some of these stocks. 

There is an 80/20 rule when it comes to options volumes in the marketplace. Approximately 80% of the total options volumes are concentrated in 20% of the optionable names. So while many stocks are technically “optionable” – meaning there are listed options for us to trade — the open interest is severely lacking and the bid/ask spreads of the options are far too wide to ascertain a fair price and to get a fill at that price. And this problem is magnified if trying to put on any kind of multi-legged spread.

The second most common reason I might ignore a setup that checks all the right boxes is simply bandwidth.

By design, I only attempt to put on about three new trades per week. And there are a number of reasons for this. In no particular order:

  1. I don’t want to manage a book of 60+ positions. My style of trading, which is to hold positions for multiple weeks or months, means that if I was firing off trades left and right in every good-looking setup that came my way, I’d quickly find myself with a huge book of positions. In certain market conditions, we can be overwhelmed with good choices.
  2. By limiting myself to only 3-ish new trades per week, I force myself to only jump into the trades that I feel are the best setups. Of course, this will always just be my opinion and I certainly don’t always get this part right.
  3. Further, by limiting myself, I resist the temptation of loading up a whole bunch of trades at the same time and then getting caught in a market-wide reversal that crushes all these new trades simultaneously. In effect, by limiting and staggering my entries, I’m leaving myself less exposed to the possibility of loading up at the worst possible time. Think of it as time diversification.
  4. Less is more. In all things. I try to live it.

There are probably a handful of other situations why I might ignore some setups. One of which is when the best setup on the board is in conflict with what the broader markets are doing at the moment (I’ll hesitate to get long into a rapidly declining S&P 500, for example). But generally, the reasons I forgo certain setups are for the reasons I’ve outlined above.

What keeps YOU out of the market?

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