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Don Kaufman here. |
Today, we're diving into a topic that's near and dear to my heart—saving you money before you even place that first trade. |
If you've ever wondered why your seemingly brilliant option trades aren't making the money you expected, stick around. |
We're going to uncover some common pitfalls that might be eating into your profits before you even get in the game. |
The Big League of Options Trading |
You know, one of the fascinating things about options trading is that there's no minor league. |
Whether you're a newbie or a seasoned pro, we're all playing on the same field. |
It's like jumping straight into the NFL without any college ball experience. |
Exciting? |
Absolutely. |
Intimidating? You bet. |
Options have been around since the 1970s, but let's face it—they've only hit the mainstream in the last few years. |
With advancements in trading technology and media coverage, retail investors now have access to tools and platforms that were once reserved for Wall Street elites. |
I saw this develop first-hand, being part of the ground floor at thinkorswim. |
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But with great power comes great responsibility—or, in this case, the need for greater knowledge. |
The Allure and the Danger of Options |
Options are like that flashy sports car—you can go from zero to sixty in seconds, but if you don't know what you're doing, you can crash just as quickly. |
These aren't just another investment vehicle… they're leveraged products that can provide obscene returns in a short period. |
But leverage is a double-edged sword. Without a solid understanding of how options move, you might find yourself losing money faster than you can say "time decay." |
That's why I always stress the importance of getting the basics down. |
If you're new to options or even if you've dabbled a bit, make sure you've got a strong foundation. |
A great resource is my free eBook, How To Trade Options The TheoTrade Way, which you can get at no cost by clicking here. |
And if you're looking for daily market commentary along with how we at TheoTrade use options, make sure to check out our YouTube Channel. |
The Illusion of Liquidity |
Let me paint a picture for you. You have a hot stock tip, or maybe you've done some stellar analysis, and you're confident about where a stock is headed. |
Instead of buying the stock outright, you think, "Hey, why not use options? Less capital, less risk, more leverage." |
Sounds great, right? |
Hold on a second. |
Just because options have these benefits doesn't mean every option on every stock is worth trading. |
In reality, there are only a couple of hundred options that offer competitive bid/ask spreads. |
That means you've got to be selective—very selective—about which options you trade. |
Digging into the Options Montage |
First things first: Always start by opening up an options montage for the stock you're interested in. |
It's a fancy term, but it simply refers to a list of all the tradable options for a particular stock, categorized by expiration dates and strike prices. |
Here's what you're looking for: |
Volume: The number of contracts traded that day. Open Interest: The total number of outstanding contracts that haven't been settled. Bid/Ask Spread: The difference between what buyers are willing to pay and what sellers are asking for.
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These metrics give you a snapshot of liquidity. High volume and open interest mean tighter bid/ask spreads, which is crucial for your trading success. |
Despite trading at over $140 per share, Nvidia offers incredible liquidity, tight bid/ask spreads, and huge levels of open interest. |
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But that's not the case with every stock option, even ones that offer options that expire every week. |
For example, check out Viking Therapeutics (VKTX). |
The $63 calls expiring in ten days have a spread of $2.85 by $4.30. |
You can drive a truck through that spread! |
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The volume is low and so is the open interest. |
Understanding Slippage: The Silent Profit Killer |
Slippage might sound like some technical jargon, but it's a silent killer of profits. |
It's the difference between the price you expect to get (based on the bid/ask spread) and the price you actually get. |
In illiquid options with wide spreads, slippage can be enormous. |
Let's say you decided to buy those VKTX call options at the market price of $4.30. |
To break even by expiration in less than two weeks, VKTX would need to jump by 8.2%. |
That's a hefty move in a short time frame. |
If you're trading options with wide spreads and low liquidity regularly, these slippage costs add up and can severely impact your overall profitability. |
Market Makers Aren't Trolling You |
It's tempting to think that market makers are out to get you with these wide spreads, but that's not the case. |
In low-volume, low-interest options, they're simply managing their risk. Without competition or significant demand, there's no incentive for them to tighten the spread. |
Think of it like buying a beer at a football stadium. |
Inside the stadium, you've got limited choices, and prices are sky-high. Outside, you have plenty of options and competitive pricing. |
In illiquid options markets, you're stuck inside the stadium with overpriced beer. |
Strategies to Combat Slippage |
So, how do you avoid falling into the slippage trap? |
Focus on Liquid Options: Stick to options with high volume and open interest. These typically have tighter bid/ask spreads. Use Limit Orders: Never use market orders in options trading. By setting a limit order, you control the price you're willing to pay or receive. "Make the Market" Yourself: If you're determined to trade a less liquid option, you can improve the bid or ask yourself. Place a bid slightly above the current bid or an ask slightly below the current ask and see if the market responds. Consider Alternative Strategies: If liquidity is an issue but you still want to trade that instrument, look into spread strategies like In/Out. These can sometimes mitigate slippage costs.
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Don't Let Slippage Eat Your Profits |
I've heard too many horror stories of traders who got their market direction spot-on but still lost money because slippage and wide spreads ate into their profits. |
It's not just about being right in direction… It's about being smart with execution. |
Remember, in options trading, liquidity is king. |
Right now, my focus has been |
Elevate Your Trading with In/Out Spreads |
If you're looking for a strategy that helps you navigate the complexities of options trading while minimizing risk, let me introduce you to the concept of In/Out Spreads. |
This is a strategy I've honed over decades in the trading trenches, and it's designed to give you a probabilistic edge. |
What Are In/Out Spreads? |
In/Out Spreads are simple, low-risk, and capital-efficient trades that can be placed with as little as $100. |
They involve buying an option that's "in the money" and selling one that's "out of the money," thereby creating a spread. |
Why In/Out Spreads Work |
Defined Risk: You know your maximum loss upfront. High Probability: These trades have a statistical edge, often winning around 70% of the time. Capital Efficiency: With a low entry cost, you can place multiple trades to diversify your risk.
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Click here to discover more about In/Out Spreads. |
To your success, |
Don Kaufman |
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