Reference: http://www.rottenstocks.com/Blogs.aspx 

I have met various traders in my life.  Being a conservative guy now, I am still trying to understand the mentality of Option Trading when one does not have enough experience with research and stock market.

I am one of the victims of hearing stories from my option trading friends – how they made $5K and how they lost $10K on a particular option. Most of the time, I hear the latter.

This does not mean that I have not taken risks in my life. I have taken some of the most ridiculous risks. I have done it all - Day Trading of Stocks, Weekly Options & Penny Stocks. I got 2-3 big successes but I lost money most of the time. But eventually, I learnt my problem. 1. I don’t spend time in doing good research 2. I listen to only one type of folks (i.e. folks who are similar to me in terms of research and risk taking)

I realized that if I do not have time, I should focus on 1 stock. Channelizing my energy in 1 stock in terms of research and traceability might be more profitable. In the real investment world, one can make a lot of money by tracking “1” stock only by actively involving in option trading OR by investing a large amount of money. This is when I discovered that QQQ is one of the best EFT/stock and it is good for option trading. Why?

1)      It is an EFT – The fluctuation can never huge(unless there is financial crisis)

2)      The 100 best companies are listed under QQQ i.e. Apple Inc., Google, FISERV, Intel, etc. Companies that are leaders in their area of expertise.

3)      Most of the time the losses of some companies are offset by the profits of the other listed companies. The maximum fluctuations I have seen in the past 6 months -2% to +2% per month(except on days when the news is about European crisis)

So, here are some of the things I have concluded for myself –

• Buy monthly options of QQQ. Why? Weekly options have a very high risk. Thursday QQQ might be @$59 and on Friday it might be 2% less or more i.e. $58 or $61
• Buy 2 types of options, one with the strike price of -3% and the other with the strike price of +3% . Why? Example – QQQ is @ $61.02 today (02/01). Buy $1000 of $63(+3%) Call Option ($0.13) for 02/18 and Buy $1000 on $59(-3%) Put Option for $0.27. I mentioned earlier that on any given month the QQQ price fluctuates between -2% to +2%. If the strike price hits $62, your CALL will sell for $0.88/options (which mean your $1000 on CALL investment is now $6700). Your PUT will sell for $0.05/option (which means your $1000 on PUT investment is now $200). Your net gain would be $4K

But, there are some ground rules that strictly needed to be follow (this is where MOST of the investors fail [Including Me]). We make the rule, we become greedy and we break the rule. This is where I lost). A lot of discipline is required -

1)      Buy the options on the end of option cycle for the next month example – buy options for 03/17/2012 on 02/18/2012

2)      Monitor the market every day. As soon as, the strike price reaches +2%, sell the profitable option. Example – If today the price is $61. You have a call for $63. If the strike price reaches $62 sell the call option. Don’t wait for it to reach $63 or $65 even if it is just the next day you bought the options.

3)      Wait for the non-sold option to reach your threshold of -2%, else sell it 7 days before the expiration date

4)      Do not buy the same option once you have sold it. Wait for the next month cycle

If I can spend more time reading about all 100 listed stocks I could strategize it better. But, the above strategy is only applicable if I am doing a dumb & low research investment.  This is equivalent to investing in black and red boxes on the roulette. The only difference is the payout of black and red investment is always the same in roulette, while the payout on PUT and CALL investment is different.