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It’s a contest where stock and ETF compete for your approval. What criteria will you apply to select the real beauties?
Today we’ll summarize qualities that the limited trading experience reported in this blog suggest a trade has some appeal. We’ll provide a sometimes tongue-in-cheek, sometimes worthwhile, rationale for each quality and how you might design a trade to make it more attractive.
| Quality | Rational | Implementation |
| Defined risk | Knowing max risk makes portolio management easier. Keeping risk on individual trades means you can make more trades, increasing the diversity of your portfolio and mitigating risk. | Don’t sell single options |
| High probability of profitting | What’s better than making a profit? | Learn to use the tools on your trading platform that provide probability of success. Learn about the inverse relationship between profitability and risk and decide how you want to balance these opposing qualities. |
| Acceptable return on risk over time to expiration | A 10% return over a month is much better than 10% in a year | Divide return on risk by number of days until expiration. Decide what your minimum should be. |
| Trade’s profit adequately covers fees associated with it | Profit eaten by fees is not a profit | Most brokers charge a fee to open and close contracts. Do the math. |
| Choose issues that have an adequate number strikes to choose from | Low-priced issues have few choices making it hard to find the delta levels you prefer to trade at. | You probably won’t many decent trades on issues priced below $20. Check it out and decide where you’ll set your metric. |
| Time decay is on your side | Tomorrow and tomorrow and tomorrow creeps in this petty pace | Favor trades with a positive theta. If a trade goes theta negative, shed it like a snake’s skin. |
| Expected changes in volatility benefit the trade | Some trades can benefit from increasing volatitly, others from decreases in it. | Check how historical and implied volatilty run in the issue under consideration. Learn about IV rank and IV percentile. Regression toward the mean provides statistical support for predicting if volatility will increase or decrease. Pay attention to how volatitility changes over earnings periods. |
| Technical analysis reveals levels of support and resistance that compliment the trade. | Other traders will be using technical analysis to inform their decisions. Having insights into their thinking is valuable. | Use the chart aggregation period you expect other traders are using. Learn how to use appropriate indicators that can aid in analysis. Take an online course in technical analysis. |
| Tight bid-ask spread | Wide spreads cause you start out in the hole. | A 10% or greater difference between bid and ask price should be viewed skeptically. |
| High liquidity | Liquidity means that your are likely to have your orders filled quickly. | Use the bid-ask spread as well as open interest and volume to identify highly liquid options. |
Key take-away: Beauty is in the eye of the beholder. Train your eye to see it.
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