Why it pays to alternate trading styles

Chris McKhann (chris.mckhann@optionmonster.com)
February 18, 2013

I find it funny that most option traders, including professionals, pick a strategy and then use it exclusively. There are the call buyers, the hedgers, the call writers, the premium sellers, and the condor hunters, just to name a few. (Those last three are all betting on essentially the same thing, but don't tell them that.)

This is why I believe it is better to have "dynamic strategies" at your disposal.

The markets are dynamic and so is volatility , yet most traders stick with their one strategy. I'm sure that there all sorts of reasons behind this from a behavioral-economics standpoint, but the point is that it is usually counterproductive to get stuck in a strategic rut--regardless of how well it works "most of the time."

This is most clearly seen with premium sellers, be they put sellers , covered-call writers , or condor traders . Such strategies do work much of the time, but they have been likened to picking up nickels in front of a steamroller .

The current environment is in some ways seems ideal for covered calls . Equities are marching higher and, while the implied volatility in options is low, actual volatility is much lower. But volatility is sure to pick up, and there are still big risks on the horizon.

As Pete has been saying, instead of owning stocks and selling relatively cheap calls against them, I would rather sell stocks I have gains in and buy those cheap calls. That gives me exposure to further gains but very limited risk in case of a pullback.

Traders might also consider using short-calendar or diagonal spreads , strategies that you don't often hear about. Buying near-term options and selling longer-term contracts with higher implied volatility takes advantage of the current term structure , which has seen option premiums come down in the nearer-dated expirations but remain elevated further out.

Those who stick with just one strategy should at least learn when to sit on the sidelines. If you keep a trade journal , you can look back and see when your strategy hasn't worked; then you can recognize when to avoid trading when those situations arise again. But even better is to have a quiver of strategies that work in various markets.

I have often heard that we should listen to what the market is telling us, as opposed to saying what we think the market will do. We should do the same with option data and adjust our strategies accordingly.

Having rules for dynamic strategies can help provide structure and increase your profit potential--regardless of how the market moves.

(A version of this article appeared in optionMONSTER's Options Academy newsletter of Jan. 30.)

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