(While on vacation until Oct 26th, I’m going to be sharing you some anecdotes on my favorite trading strategies: why I use them, when, and how I manage them once they are on.)
Here’s the thing about options trading: you can make it as complicated as your heart’s content. And there are plenty of incredibly smart practitioners out there who run amazingly complex strategies involving all kinds of volatility and statistical arbitrage.
They analyze 3D volatility surface graphs, use lesser understood greeks, and interpret things like “volatility smile” and dispersion.
If that works for you, great! I always say: if it works, do more of it!
But another beautiful thing about options trading is that there are many different ways to pull profits out of the market, and most of them aren’t as complicated as they may sound — even if the strategies have exotic sounding names like “iron condor” or “broken-wing butterfly.”
And my absolute favorite options strategy isn’t even really a strategy at all — it’s simply buying long calls when I’m bullish!
It’s the most basic of basic ideas. I pay a premium to purchase a call option, and if the stock or underlying goes up I make money and if it goes sideways or down, I lose money. But I can’t lose anything more than the purchase price of said option. It’s got risk management already built in! Easy.
I’ve oversimplified, but you catch my drift.
The first way I tilt edges in my favor with long calls is to only purchase them when implied volatility is relatively low. The surest way to lose money in a long call is to overpay. And if volatility is high (for whatever reason), then premiums will be elevated and I’ll look for a different strategy to express my bullish thesis.
Assuming volatility is low and I’ve gone ahead and purchased the call options, another way I tilt edges in my favor is to systematically reduce risk when a position goes my way. I’ve made it a best practice to sell half of my position if the calls have doubled in value. For example, if I purchased ten calls for $1.00 each, that would represent a $1,000 investment (multiply the premium paid for each option contract by 100 as each contract offers the right to purchase 100 shares of stock). If the value of the calls doubled to $2.00 per contract, I will sell five of my ten calls, which would net me a $1,000 credit.
This accomplishes a number of things for me:
- Receiving the $1,000 credit for the 5 contacts I exited nets against the $1,000 debit I paid to enter the 10 contracts, leaving me with a net cash flow of zero while still holding the remaining 5 long calls! This means I’m essentially now holding these 5 calls for free!
- As breakouts fail often, this protects me from turning a winning trade into a loser and increases my overall win rate when viewed over a longer series of trades.
- Selling half dramatically reduces my temptation to trade out of an entire position too soon. As a position goes my way and profits begin to pile up, the daily and intraday PnL swings begin to increase in magnitude. At best, these swings become a distraction. At worst, they trigger all kinds of bad fear and greed impulses — none of which result in smarter decision making. Taking my original risk off the table is my way of saying to myself: “Ok Sean, now you’re playing with house money. Chill.”
- Playing with house money gives me tremendous confidence to hold on to a position and play for a big win. To really go for the “unlimited profit potential” that is the embedded allure of any long call option. The Big One doesn’t come along often. Maybe once or twice a year. But you only need one to make your whole year and if I’m lucky enough to get ahold of two or three of them, then it becomes a very good year indeed!
Do I need twin advanced degrees in quantum mechanics and thermodynamics to work the math of a simple long call trade? Of course not.
I like to keep things simple around here. It helps me sleep and it keeps me out of trouble.
If nothing else, I hope this little riff on long calls inspires you to keep things simple. Do you have any fun stories about an adventure with a long calls positions? I’d love to hear it. Shoot me an email — firstname.lastname@example.org.
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