Option Traders: the good the bad & the ugly

[wayneL]

Found this interesting and something I've talked about in disparate bits and pieces, all bundled up in one post. Hat tip to theoptionsjunky

This from Michael Catolico from TheOptionClub Yahoo group.

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The assumption is that any strategy followed over and over
again will end up with zero profit. and yes, I believe that adjustments
are the key to profitability - or rather, skillful adjustments are what
separate the winners from the losers.

if I can digress for an indulgent bit, let me suggest that there are
really only three types of folks that actually win at options trading
(sort of my version of the "good, bad & ugly"):
1 - the lucky
2 - the fortune tellers
3 - the skilled

Every new trader should test to see if she or he is actually lucky
before ever wasting a moment trying to learn about the market. The way
to do this is simply to take say $5,000 buy some short term options
randomly or "on a hunch". Then, whatever happens to that trade, take the
proceeds and plow the entire amount back into a similar guess-type trade
the next month. Do this until you either lose the whole $5k or turn it
into $4-$5M. at which point remove your money and never make another
trade again. I would put the odds of actually being this "good" are
really about 100 million to one but oddly I have personally known two
people that fit this category. The first mistakenly took his success as
a sign of skill and proceed to give it all back and then some. The
second was smart enough to know it was a fluke and took the proceeds and
started another business (which he is actually good at) and turned that
nest egg into a lot more golden geese.

The "bad" in my little metaphor is the catch-all category of "fortune
tellers". Most people know these types by the more familiar terms as
technical analysts and fundamental analysts. As you probably know I am a
believer in "weak" efficiency for the market. This is mainly because I
have never been able to predict either price or volatility direction
with anything better than 50/50 success. Not that I haven't spent a lot
of years trying both sides including a decade or more of immersion in TA
and spending time and money to get an mba in finance/accounting and a
cpa to boot.

Just because I could never figure out how to predict the future doesn't
mean that there aren't some who do. But here's why I call this category
of winners "bad": almost every guru and market "expert" is out there
peddling a system or method essentially premised on "finding winning
trades," and following this line of thinking ultimately busts out most
traders. Most novices and in fact most retail traders believe that
predicting the future is the key to winning the market and sometimes
cautiously, often gullibly, latch on to the system sellers and
prognosticators. They spend very little time learning much about how
options work and, in truth, if they are actually very good at picking
winners, don't need to know much more than that options help them
leverage those predictions. I’d say that no more than 1 in 100 actually
have the ability to consistently pick winners at better than even odds.

The way to find out if you are a fortune teller is fairly complex but
testable. Get yourself reams of historical price and fundamental data.
divide the data sample in half. on the first half, find 30-40 assets
that beat or failed to match the market by +/-20% or more in a three
month period. Use all your perception, reasoning and intuitive powers to
find some common denominator in that group of anomalies. then take that
finding and screen the other half of your sample. if you find that you
can spot similar outlier/big movers in the test sample with your method,
you may have struck the mother lode and are probably a bona fide fortune
teller. [needless to say, but obviously anyone touting a system or
method publicly has either tapped out on a formerly successful system or
is just a scam artist - the only way to discover a winning method of
this sort is to create your own.] trade this discovery/knowledge
carefully and as you build up a continual track record grow your wealth
to the millions or more mark. again i would caution that if you ever
reach the "richer than you need to be" stage, bow out and never trade
again. but in this instance you can then sell your secret method for
additional untold millions.

the final type of winner is what i would term an "ugly" trader. this is
the kind of person that somehow manages to always and consistently find
a way to make money. regardless of market direction, regardless of
volatility, regardless of liquidity, etc. they are usually huge students
of this game, can erect and dissect a position as though it were second
nature, are obsessed with risk (both in protecting against disaster and
embracing certain types of extremes) and can trade instinctively. this
category is the one that i believe most folks should either aspire to or
eventually wind up pursuing after failing at the first two categories.
unfortunately i would say only 1 in 20 or so ever achieve any kind of
success as skilled/ugly traders.

if you'll notice, when you add up the odds, i'm suggesting only around
6% or so of traders ever wind up being big or long term winners. but
that is the grim reality of trading. and when you realize that options
hold negative odds similar to casino games like blackjack, you'll know
why i tend to preach cautiously when i respond to discussion threads on
these boards.

Michael

 

[Mofra]

the final type of winner is what i would term an "ugly" trader. this is
the kind of person that somehow manages to always and consistently find
a way to make money. regardless of market direction, regardless of
volatility, regardless of liquidity, etc. they are usually huge students
of this game, can erect and dissect a position as though it were second
nature, are obsessed with risk (both in protecting against disaster and
embracing certain types of extremes) and can trade instinctively. this
category is the one that i believe most folks should either aspire to or
eventually wind up pursuing after failing at the first two categories.
unfortunately i would say only 1 in 20 or so ever achieve any kind of
success as skilled/ugly traders.

I found this paragraph extremely interesting, in the context of reading many posts by Wayne, Sails, Duc, Mag etc on trade management & strategy selection depending on the set-ups.

I expect the dynamics of options trading is a major attraction in that merely "direction picking" appears to be a mere assumption of risk by the trader, without the flexibility of risk manipulation to change the odds (or "expectancy" in trader land). Personally I use more low profit ratio/high degree of success type set-ups, as without constant market monitoring these are the trades that suit my lifestyle & current situation.

Very interesting reading

 

[money tree]

 

[Glenhaven]

I mostly trade equity options and I have a few rules, one of which is "never sell an uncovered call". The risk of a major loss is just not worth it in my view.