For a directional trade, there are two choices: unlimited opportunity and limited opportunity. With unlimited opportunity, the farther the market moves the more profit gained. Since newer traders believe that this is the only way to trade, this is often the trading style that they use. Directional trades will generate more profit than any other trading style in options, but it also has the highest losing rate of all the options tactics.
With a directional trade, the options position needs to see a move in the market or the trade will lose. The move needs to cover the debit cost of the position first (just to see “break even”) and any move beyond that will generate profits – if the move in the market is happening fast enough to increase the value of the option beyond the options daily Theta decay. If the move is not happening fast enough to cover the daily Theta decay, then the option position begins to lose.
There are three industry pieces for trading directionally with options; constructing trades “near” the money or constructing trades OTM are two things of importance while a third piece of options logic is “days to expiration” or DTE. For directional traders strike location and DTE define a large part of the trade outcome and overall cost.
To effectively trade a directional strategy an options trader needs to understand the consequences of their choices; what is the effect for buying an ATM option with 28-DTE versus buying a 30 Delta OTM option with 47 DTE? How do we evaluate these two trades and make an informed decision about the “better” choice for our trade expectation?
Individually – we would want to understand the list below and learn these important details; once these pieces are understood a trader has more information about how they want to approach a market and what sort of options trade they should use to gain edge.
- Understanding the logic for the Strike choices
- Understanding the “fair price” of an option
- Buying Calls / Puts
- Constructing and Buying Verticals
- Constructing and Selling Verticals
- Building / Analyzing / Trading complex spreads
- Recognizing Risk / Grasping Probabilities
- Adjusting or Managing Trades
Understanding the price action on a chart already has difficulty, complexity, and risk; adding options to the situation without fully understanding the things listed above just increases a traders exposure to loss. We must have an edge in trading; without an edge a retail trader will constantly struggle to identify successful opportunities.
Coaching
Interested in learning more about directional options trading and how you could use it to trade options more effectively? Reach out to Signet and request a free consultation for One on One coaching today!
