I believe an important exercise in trading is to review closed trades, chart work and methodology. It is a valuable exercise because you now have the benefit of knowing the outcome of your original thesis. This enables you to spot trading errors, revamp your current thesis and tweak your trading methodology. Through this practice, I developed my own trading rules that I'd like to share with you.
I have so many rules about options it's not even funny -- and all designed to protect me from myself. For instance, I don't trade directionally with highfliers in options. No Intercontinental Exchange (ICE), CME Group (CME) or Google (GOOGL) -- I just don't do it. I don't trade anything in options that can hurt me. I don't take position sizes that can mortally wound. I am content with nice singles and doubles as they add up quickly over time. I wouldn't know what to do with myself if I couldn't trade, and since I have a growing portfolio, I don't take crazy chances.
I trade with respect -- and with a purpose for my life.
- I respect my money by using appropriate position sizes. Just because you can afford to buy $50,000 worth of Apple (AAPL) stock, doesn't mean you can -- or should -- buy $50,000 worth of Apple options.
- If the option has a nice pop right off the bat (like overnight) and I get gains of 30% to 50%, I sell my position immediately. I can always get back in.
- If the option position doubles over time, I sell half at the point it doubles and let the rest do its thing.
- If after paring down my position the option returns to my entry price, I exit.
- If the trade goes against me from the beginning, I will exit at a predetermined maximum cash loss, or at the point that the option loses 50% of its value, whichever comes first.
- If an option gaps down and blows past my stop and is down 80%, I will hold it and do nothing because, generally, it will correct a touch so I can get a better exit -- not an even exit, just a better exit. This happens to everyone. Less than 80% on a gap and I take my lumps immediately and exit.
- I do not buy options on an illiquid stock.
- If an option has not made any directional progress in the first week I own it, I exit.
- If trading an option because the stock is going to a predetermined price, I will exit the option when the stock hits its target.
- For each $1,000 gain in an option's position, I sell enough of the position to bank that $1,000.