Selecting the proper strategy ultimately determines a trader’s level of success, writes Dan Passarelli, citing eight factors option traders must evaluate when making this critical decision.

One of the more difficult problems for options traders has historically been the broad bid-ask spreads quoted for options. Experienced traders have routinely negotiated the bid-ask spreads downward with varying success when trading individual positions, but the non-economic price has been the significant effort and time required to achieve these negotiated results.

Beginning in January 2007, CBOE initiated a pilot program to reduce bid-ask spreads to as low as a penny. As of February 28 of this year, there were currently 360 in the series (including big names like Apple (AAPL), Microsoft (MSFT), and more) quoted in these penny increments. (CBOE maintains an Excel file of option series currently included within this “Penny Pilot” program here.)

Because option positions are frequently constructed with several individual legs, the impact of the ability to trade with tighter bid-ask spreads can have significant impact on the aggregate slippage of positions. Combined with the falling commission rates resulting from the increasingly intense competition amongst brokers specializing in options, significant trading efficiencies have resulted.

Do you know how many different types of options strategies there are? A lot; that’s how many! But that’s not really the important question. More importantly, do you know why there are so many different types of options strategies? Now we have something to discuss.

Different options strategies exist because each one serves a unique purpose for a unique market condition. For example, take bullish AAPL traders. Traders who are extremely bullish on AAPL get more bang for their buck buying out-of-the-money calls. Less-bullish AAPL traders may buy at- or in-the-money calls. Traders bullish just to a point may buy a limited risk/limited reward bull call spread. If implied volatility is high and the trader is bullish just to a point, the trader might sell a bull put spread, and so on.

The differences in options strategies, no matter how apparently subtle, help traders exploit something slightly different each time. Traders should consider all the nuances that affect the profitability (or potential loss) of an option position, and, in turn, structure a position that addresses each nuance.

Traders need to consider the following criteria:

  • Directional bias
  • Degree of bullishness or bearishness
  • Conviction
  • Time horizon
  • Risk/reward
  • Implied volatility
  • Bid-ask spreads
  • Commissions

Carefully selecting options strategies makes all the difference in a trader’s long-term success. Leaving money on the table with winners or taking losses that are larger than necessary can be unfortunate byproducts of selecting inappropriate options strategies. Be sure to spend time optimizing your options strategies over the next few weeks to build the habit.

By Dan Passarelli of MarketTaker.com

Related Articles
  1. Stock Analysis

    How Toyota Succeeds at Home and Abroad (TM)

    Japan's biggest car manufacturer is also one of North America's biggest, delighting shareholders with its high profit margins.
  2. Budgeting

    Trunk Club Review: Is It Worth It?

    Take a close look at one of the best-known online clothing services in the country, and determine whether it's a good fit for your style and budget.
  3. Budgeting

    HelloFresh Review: Is It Worth It?

    Discover one of the world's most successful meal subscription services, and learn more about how the service operates and what it costs.
  4. Stock Analysis

    Starbucks: Profiting One Cup at a Time (SBUX)

    Starbucks is everywhere. But is it a worthwhile business? Ask the shareholders who've made it one of the world's most successful companies.
  5. Stock Analysis

    How Medtronic Makes Money (MDT)

    Here's the story of an American medical device firm that covers almost every segment in medicine and recently moved to Ireland to pay less in taxes.
  6. Investing News

    Latest Labor Numbers: Good News for the Market?

    Some economic numbers are indicating that the labor market is outperforming the stock market. Should investors be bullish?
  7. Budgeting

    Just the Right Book Review: Is It Worth It?

    Take an in-depth look at Just the Right Book, a subscription service that delivers personalized book selections based on your reading history and preferences.
  8. Investing News

    Stocks with Big Dividend Yields: 'It's a Trap!'

    Should you seek high yielding-dividend stocks in the current investment environment?
  9. Investing News

    Should You Be Betting with Buffett Right Now?

    Following Warren Buffett's stock picks has historically been a good strategy. Is considering his biggest holdings in 2016 a good idea?
  10. Products and Investments

    Cash vs. Stocks: How to Decide Which is Best

    Is it better to keep your money in cash or is a down market a good time to buy stocks at a lower cost?
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center