Stock Option Trading Tips

These are some tips that I have to keep reminding myself over and over, which I learned first from working as a market maker on the options floor of the Pacific Stock Exchange, then as an individual investor. My biggest problem is holding on for too long.

1. Options are not long term investments. When you have a quick profit, sell.
2. LEAPs are options, and are therefore not long term investments. The premium will continue to decline and they will expire. Therefore, treat as any other option.
3. If an option increases by 25% or more in one day, sell! Don’t wait another day, another hour or another minute for it to go higher. Chances are, whatever drove that spike in price will not be enough to carry it higher the next day.
4. One advantage that investors have over options floor market makers is that investors can place limit orders. Take advantage of that benefit.
5. Another advantage that investors have over market makers is that if they are bidding the same price on an option, investors always have priority. For example, if the market maker is quoting ‘4 bid, 5 asked’ for an option, and you have a limit order on the books to buy at 4, if a market order to sell comes in then your order would be transacted first. (By the way, a market maker trades for his own account, unlike a floor trader who trades for brokerage firms representing orders from individuals and institutions.)
6. Writing naked options can work over long periods of time but eventually you will get burned, and all those long term profits will be wiped out.
7. Never place a market order for an option, unless you need to bail out or jump in immediately based on sudden news.
8. When placing a limit buy order, try placing it slightly above the bid price, so if any market orders come in, your bid will be hit first. For sells, try placing slightly below the asked price. This is especially true for options with wide spreads.
9. If most call options on a particular stock close up at the end of the day and the stock closes down, more than likely the stock will be up the next day. Take advantage of that opportunity by buying the stock in the aftermarket.
10. One other advantage that investors have over market makers is that they don’t have to ‘be at the opening bell’ and ‘be at the exchange’ a minimum number of times per year to comply with exchange requirements. What that means is that you don’t always have to be invested in options. Take a long break from option trading if you need to. There is a time to buy, a time to sell, and a time to do nothing.

By Fred Fuld for Stockerblog.com.