We often hear about traders making lots of money in the markets using a specific strategy. With the ability to trade online, and having access to trading platforms that provide a wide range of capabilities (charts, studies, indicators, alerts, etc.), most strategies are technically based relying on simple studies and indicators.
While it is certainly true that many traders are making money with these strategies, the reality is twofold: first, profitability for these traders are typically volatile, with some big losses (read "Reminiscences of a Stock Operator" by Edwin Lefèvre, as an example of the ups and downs of trading); and second, for every successful trader using a particular strategy, there are likely hundreds that are not successful.
This article is not about the best study or combination of indicators that will lead to consistent profits; it is about taking the next step in understanding how to trade the markets that offer the ability to make consistent income for a large majority of traders; not just a small number. This article is the first in a series that will explore that next step.
When trading an asset (stock, ETF, future, etc.), you do so with the expectation that the asset will move up or down. Statistically speaking, the probability of being right about direction is 50%; you are either right or wrong. Many feel that an indicator (MACD, Stochastic Slow, Moving Average, Pivots, Support/Resistance Levels, Fibonacci Levels, Cycles, etc.) or combination of indicators offer a means of increasing the probability of being right about direction. Perhaps, but independent research conducted throughout the decades have shown that indicators really have no predictive value (their real value is engagement; getting you in the trade).
With the explosive popularity and resulting high volume of options, this derivative offers an attractive alternative to assets for two reasons: First, it requires far less capital to trade assets that are too expensive for small accounts (like Apple and Google). And second (and more importantly), options offer strategies that can go far beyond the typical 50% probability for assets; strategies like the credit spread, naked short, iron condor, and strangle which offer probabilities in excess of 90%.
Now, to be clear, there is a tradeoff when you increase the probability of profit (POP); especially when POP is in excess of 90%. That tradeoff is less profit for a given level of capital at risk; in other words, a lower return on capital (ROC). For many at first glance, this is reason enough to avoid such strategies.
For example, would you consider a strategy in which the capital at risk is $2,500 to earn $100? The ROC on that trade would be 4% (100/2,500) for a POP of 96% (100% - 4%). While this might seem unattractive, the answer to considering this trade is: it depends. It depends on the probability of max loss (POML), which only occurs when the lower strike (for spreads and iron condors) is reached or exceeded (for naked shorts and strangles, you could look at the strike that is one-standard deviation away from the short strike to calculate the POML). Note: most trading platforms for options will provide these probabilities.
If the POML is just 0.6%, we can calculate the expected return for the trade. The calculation is: (95% x $100) - (0.6% x $2,500) = $95 - $15 = $80. A positive value is good, and the higher the value or percentage of max premium ($80/$95 = 84.2%) the better; if the value is negative (or very near zero), you should consider another trade. Admittedly this is a very simple test, but it does enable you to compare competing trades under consideration, and going with the trade that has the highest expected value or percentage.
The question, naturally, is: do these strategies work providing consistent income? To answer this, we consider the experience of Karen the Super Trader (a name given to her because of her extraordinary success trading SPX strangles).
Karen is a retired CFO from a small firm who was considering opening a bagel shop with a friend, until that friend discussed the possibility of trading.
After spending $20k plus on courses, Karen's trading experience eventually led her to options, and eventually trading a high probability approach (initially iron condors, then strangles) with SPX options.
The results: she is now managing two accounts worth approximately $100 million; all within a period of four short years. Not bad for a retired accountant.
Karen's success as a non-professional retail trader is an inspiring story, and underscores the advantages of options and the high probability strategy. There are two video interviews in which Karen discusses her success and is well worth watching.
To watch these videos, just click on this link at OptionsAnnex.com.