XJO (ASX) What are my Options?

Originally posted by Zonetrader ↑

Hi Orwell, I haven't forgotten about starting a new thread but just not sure where is the best place to put it. XJO has a long standing tradition of only one thread per day so I'm reluctant to start an options thread in the XJO forum. I think ETOs need their own thread as there have already been quite a few discussions which are now losing continuity and difficult to find in the daily threads. I could start one in the ASX-general forum and then move it over here if Redbacka and others are happy for one ETO thread to run in here in addition to the daily XJO threads.

I have looked into a lot of option selling strategies but, like you are finding, I didn't like the risk to reward even though the probabilities tend to favour those types of positions. Even if 9 out of 10 work out OK, it only takes one strong move to wipe out s those months of small premium collection - and sometimes more. I know a couple who lost their house selling naked options so the risks are very real. That was on an individual stock where there was bad news and the share price halved after a trading halt. Index options safer in that regard and also the risk of early assignment is removed as they are European styled options meaning they are cash settled at expiry.

Personally, I prefer to use charts, etc to try and give a decent probability of direction and set up low risk trades to benefit should the market go in that direction. It's possible to set up low risk trades in both directions and then sometimes adjustments can be found for the losing position. I started learning options in the early 2000s and it's been a continuing learning curve. I don't trade all the time and prefer to wait for good opportunities to place low risk positions - what those positions would be depend a fair bit on IV as I want that working for me. Gamma and Delta are also important concepts to understand. In a strong move, gamma is the enemy in a naked short position and is a friend to a long position. Going from memory, the gamma curve is around 30 and it's where the option will start to gain speed with direction.

Another thing I look at is options open interest in the index to help identify support and resistance levels. It's not foolproof by any means but it's another tool in the toolkit. Currently for Feb options, the highest open interest levels are around the 5600 mark and the lower lever around 5150 (although there are others starting to build a bit lower) so that can help in deciding which strikes to use. Maximum Pain is another interesting theory but again, there's no guarantee it will work all the time. This website explains more: http://maximum-pain.com/

If I think the market is going down - I might look at buying an out of the money bear put spread (options below the money usually have much higher IV, so the sold option is used to help hedge against falling IV if I'm wrong). If the market does go down, I can either just close out the bear spread or I can apply a butterfly spread which effectively moves the trade down and locking in some profit while allowing it to run a bit more. Of course, a broker with reasonable fees is a must for these sort of moves. I see the market much like a game of chess where it makes it's move and then I make mine when I'm ready. I'm not a professional - just a retail trader with a lot of trial and error in attempting to find what works best for me and the money management limits I set. I have learned so much, it's not possible to put it all into a few posts! Everyone is different and there are so many ways to trade options, I think it's important to paper trade and experiment until you find what you are comfortable with.

While there are base strategies, they all have so many variations. Butterflies can be staggered so they are directional - called broken wing butterflies. Butterflies can be placed diagonally - same with Calendars and debit/credit spreads. They can have added wings added when IV is low as a directional hedge. Just so many things can be done, however, each one has their own risks and so it's important to know under what circumstances that trade might start to get into trouble and have a pre-determined plan on how to manage in the event that happens.

I think it's a case of doing a fair bit of paper trading to see what suits your own risk profile and money management is vital especially with the high leverage we have with option trading.

Check out Karen Supertrader on Tasty Trade - she sells US options and at the time of the video had her own managed fund. Interesting and somewhat tempting, but way too risky for me. I would rather pick up those few points when I can on a few well placed directional trades.

Hope that helps a little bit...

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Hi Zonetrader, I really appreciate your thoughts and the detailed reply.

Much of what you say aligns with my thinking but with a few new ideas in there. Gamma I had ignored for the moment but thanks for the tip on how to think about it. Open Interest I found hard to apply on stocks as the market is a bit thin anyway, but thanks for the tip for Index options.

Karen of Tasty does wide Index Short Strangles on three major indices in the US, set about 2 Standard deviations from the money. It appears a very profitable strategy but risky. I think she made her big money during the GFC years when volatility was exceptionally high. But it wouldn’t surprise me if she blew up her account if another 1987 style market crash occurs. For me I’ve decided its too risky to do Naked Options due to potential outlier events that will occur on all markets, particularly with current distortions around the world. I wonder how many forex traders had equivalent naked type positions over the Swiss Franc in recent days. A better approach appears to be wide wings on those types of trades, with the long position just giving some insurance against outlier events. See Tasty’s “Big Boy Iron Condors”

Butterflies are interesting but I heard they were lower probability of profit trades. Also not the starting point for me I don’t think but will get to them. The key to Options trading of all types seems to be to get to a level of competence to be able to adjust positions properly as you allude to with your Butterflies, by putting on additional positions. I’m not there yet.

My understanding is that Option traders are generally all about trading volatility, rather than direction. However I have a well-developed technical/charting approach and will always take a directional view and so I think I can use this to get closer to the money with selling strategies and maybe make it work. But I’ve been surprised at how hard it is to find viable positions with reasonable risk reward. It sounds like that’s a shared experience.

My conclusion so far with Options is firstly, that you need to be expert in this not just competent, through paper trading or whatever, before you can be profitable. Secondly its about finding trades with small edges and margins to scratch out a return rather than any easy low hanging fruit.

The other understanding I have with Options is money management is even more important than with other forms of trading I’ve done. Written positions to be 2-3% of portfolio only and diversified, uncorrelated positions as much as possible. Lots of small position to allow the probabilities to work in your favour. Nevertheless I can see how you could creep lots of small gains and then wipe it out with a big loss.

Anyway, lots of thoughts here on all this. Really great to hear the experiences of another trader trying to do this on our market.