What’s my time frame?
There are a number of ways to classify my trade, and each classification requires a different entry and exit style. People often allow short-term scalps to turn into multi-day holding periods when they start to go against them. Then, as the short-term scalp becomes worse, it becomes a long-term investment. This is a lack of discipline that needs to be eliminated. And this is why there have been so many moves toward machine-based trading – machines don’t ignore stops or justify holding a position for “just a little longer.” Machines also don’t understand trader psychology and require a large amount of data to replicate years of experience.
Let’s dive a bit more into the types of trades one can enter and how the entry and exits could be determined:
Generally, this is going to be a trade that shows some sort of technical input that allows one to think there can be a fast move. Many times, these technical indicators work because machines and humans alike both look at them and can set clear entry and exit points based upon the chart formation. The technical points may be crossed due to fundamental news (such as earnings, M&A, new investor, etc.), but the key that gets the machines moving is likely to be crossing a technical level.
If I am entering the trade for the day, then there is no reason to use options that expire in more than 2 weeks. If I am buying off a technical breakout, then I am looking for Delta exposure primarily and Gamma secondarily. Vega really doesn’t matter all that much for this trade. I can enter with an equity position if there is a clear stop below, and I can enter with an options position if the IV level is low relative to the short-term move potential. The key here is to still exit the trade if I reach my lower or upper target – I don’t want to let a short-term options play turn into a new long-term holding if the trade justification is short-term technical action.
Mid-Term Technical Trade:
This is more likely to be something that can be expressed via options only if implied volatility is low, and generally much more easily in a bearish environment, as IV tends to rise when equities sell off. That does not mean that I cannot trade these in a bullish environment. I have had great success buying calls on technical break outs, but I have to recognize that there’s even more leverage in a bearish environment.
Crossing the 200D MA or holding at support/resistance at the 200D MA is an interesting entry point for this type of trade (although there are many other technical setups that provide more leverage with outright options). Testing the 200D MA is fairly simple, but can confirm a flip of a trend or continuation of a trend. Because I expect this to not necessarily hit big stops as the price rallies (or sells off), the trade is more about Delta and Vega in the intermediate term rather than Gamma. Once the directional position is confirmed, it becomes a trade focused on Delta and Gamma as other traders chase the trend. So, I like to look at long positions in out-of-the-money options that expire in 1-2 months for this trade. There is less Theta if I am wrong and the Gamma picks up once the trend is confirmed over the next 1-2 weeks.
Once again, I adhere to stops. Just because risk is defined does not mean that I should allow myself to lose all the premium in the options trade. If the 200D MA cannot hold after all, then the technicals are telling me that the trade is wrong. So why waste the premium on hope?
Long-Term Fundamental Trade:
This is the most difficult trade overall. It requires long-term holding of positions and is difficult to exit. If I think a stock can triple over 2 years and it rallies 50% in 1 month, do I trim positions or wait for the balance of the move? The answer is not easy, and it creates further difficulty if I try to enter a long-term bullish story via options. I like to enter this type of trade using longer term call spreads as there is no strong benefit to having Vega or Gamma, but the benefit is getting some defined risk, a little bit of leverage, and most importantly, a Delta exposure. I can rest easier being long a deferred call spread than being long an equity in some cases, and so that would be how I could enter this trade. Implied Volatility and skew become a bit more important in this type of trade as the nuances of options are being traded and Vega and skew impacts can be significantly more pronounced with longer times to expiration. So I have to be careful with this type of trade. Because it is very difficult to take a loss on a long-term fundamental trade (if I liked the stock for $100, I have to LOVE it for $50, right?), it can be easier to set up a call spread position and leave it. BUT, if the fundamentals change, that means I have to exit – so while I may not care as much about short term technical signals, I better watch earnings, news releases, etc. and make sure my fundamental thesis is not debunked.
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