Trading Options in Turbulent Markets by Larry Shover

Author:Larry Shover
Language: eng
Format: epub
Publisher: Wiley
Published: 2012-11-26T00:00:00+00:00

Developing an Approach to Options Trading

An often overlooked feature of risk tolerance is discovering your own style. There are three distinct options-trading approaches. Each one differs in emotion, time commitment, trading horizon, analytical tools, and intensity. An options trader fits into one of these styles according to individual personality, objectives, and lifestyle.

The Day Trader

Day trading is the buying and selling of options and/or options strategies multiple times during a one-day trading period. The intention of the day trader is to find discrepancies in the market, such as over- or undervalued volatility, mispriced spreads, and directional bias trades, and then to take advantage of them. Furthermore, the day trader is predisposed toward making a large number of wagers with very small reward.

Day trading with options used to be extremely unprofitable in the days before brokerage firms started to offer deep discounts for options trading. The situation is different today for several reasons. First, the cost to execute trades for the retail trader has dropped to the extent to which the day trader can now be marginally profitable and still realize a profit. Second, the advent of cheap access in the form of low brokerage fees has served to add an enormous amount of liquidity to the options market. Bid/ask spreads are generally much narrower than in the past. In some cases, bid/ask spreads are so tight that the result is a margin market that almost becomes a “choice” market where you can buy or sell at nearly the same price.

Effective day trading requires technology, from specialized brokering platforms to software trading systems and even a live streaming data feed. Because so many factors and events can move an underlying asset price by the minute, effective day trading demands a heavy investment in tools in order to level the playing field with professional market makers.

Day trading can also be time consuming. To be effective you will need to be in front of your computer all day, every day. It is impossible to act as a part-time day trader, because it is impossible to achieve analysis and proper decision making on the fly when variables are constantly moving. Also, profitable day trading demands high levels of discipline and skill. It requires great analytical skills and an ability to execute trades mechanically.

Day trading can be extremely risky for two simple reasons. Day trading is expensive, and most traders lack the discipline needed to succeed. Beginning traders (and some veterans) generally do not have the emotional control required. Most aspiring day traders find themselves doing all the wrong things, breaking the rules, and spoiling every trade, especially during volatile market conditions. Volatile markets are normally the most profitable conditions for market makers. But watching profit and loss profiles fluctuate in big waves and being bombarded by news every second results in one of the most emotionally challenging environments in the world of investing.

Also, because day trading is an approach that depends on a high volume of trades, the commissions add up even with the deep discount brokers available today.

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