If you’re anything like me, you started trading by figuring out what kind of analysis you like, what strategies looked interesting, and throwing stuff out there seeing what sticks. The goal of this post is to reframe this process for newer traders and offer a better route to creating a successful approach to trading options.
Options are a trading vehicle, nothing more. They by themselves offer precisely no edge. A common misconception by theta gangers is that theta is their edge, it absolutely is not. So what is?
This should be the very first step for every trader before you ever place their first trade - research what market effects you THINK you can profit from and quantify that it exists. Some very basic profit mechanisms:
* Being good at determining direction and trading underlying movements
* Finding market effects, like monthly bond rebalancing, and trading the coat tails of larger players
* Identifying pivot points or areas of consolidation and trading a stock as it bases
* Trading persistent market inefficiencies such as the general overpricing of volatility compared to realized volatility, variance risk premiums
There are literally an unlimited number of ideas a trader can explore. But before deciding if you want to buy a 0.50 delta call or the 0.52 delta call, first study the effect you’re attempting to profit from and get really good at identifying it. This doesn’t mean lazily looking at a few dozen charts and thinking “you got it”. It’s applying rigor to your research and quantifying it.
Once we’re confident in the effect we’re attempting to trade, we can then build an option strategy around it.
Like most of my profit mechanisms, they’re childishly basic in nature. For example, trading the IV collapse post earnings releases. Before figuring out if I wanted to trade straddles or strangles, short DTE or longer DTE, I first need to understand the behavior of the effect.
The main point is very clearly identifying the very specific market effect you are trying to trade. By taking the time to clearly define this, it makes it much easier to reason through how to best capture it.
Good luck out there.