Option Investor
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Top Ten Rules for Option Trading

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As promised here is my top ten rules for surviving and prospering in the options market.

1. Never put all your money into one play. As soon as you do Murphy's Law will take control and you will be broke. With a $2000 account put $1000 into two plays. $5000 should divide into 3 plays, $10,000 = 3 to 5 plays maximum. I strongly recommend NEVER playing more than 3 to 5 positions at one time. You cannot watch more than three and act decisively when the situation demands action.

2. Never hold a position over an earnings report. Historically the number of stocks that rise substantially after an earnings report is less than one in ten. Sure there are a rare few that gap open on great earnings but far more gap down. To gap open they must beat the whisper number by a LARGE margin AND have a good conference call. To go down they only need to meet the whisper, meet the estimates, miss the estimates, prewarn any problems or just plain not be positive enough in the conference call. Traders leaving after playing the earnings exert enough pressure on the price as it is without bad news.

3. Never play deep OUT OF THE MONEY call options. Sure they are cheap but they are cheap for a reason. They are like playing roulette and betting on any one number. If you hit the payoff is 35 to 1 but the odds of being hit are 38 to 1.

4. Never put in a MARKET BUY before the open. You will more than likely get filled at the high of the day. Enthusiasm is rampant at the open and everything costs more (as a rule) than it will an hour later.

5. Never place a market order for a thinly traded option. You may take out the current ask and be very shocked at how high the next ask was. Several times I have seen fills more than $2 over the current ask quote.

6. Always pick a sell price you would be happy to get BEFORE you buy an option. Immediately after purchase place a limit sell for that price. You will be surprised how many times you will sell on an intraday spike that you did not expect. See #5 for why. Decide how much you are willing to risk on the trade BEFORE you make it. Sell when that limit is reached. Ask anybody who ever had an option expire worthless. They will all tell you now "they wish they had sold". At the time emotion will always convince you tomorrow is turnaround day. Hundreds of thousands of contracts expire worthless EVERY month. Turnaround never came for them.

7. Never bet against the market/sector. The trend is your friend. It does not matter why the market/sector is going down you will still lose your money. 85% of stock movement is due to market/sector movement not stock fundamentals.

8. Always sell when you pass 100% profit. If you still like the play take half the money and buy back in at a higher strike. Once you sell they can't take the profit away from you. Don't play 100% of the money again. Double or nothing will eventually get you nothing.

9. Emotion is your enemy, logic is your friend. Never trade on emotion. There is no such thing as "it has to go up", "it can't go down". The market does not care what you think or hope. It is ruthless and makes its own rules. You should say this 50 times a day, "past performance is not a guarantee of future results".

10. Never buy on impulse. If you just heard the news, it is already to late. Plan your buys during non market hours. Once the bell rings your mind is clouded, emotion takes over. Plan your strategy, execute your plan. When in doubt, stay out.

PS: Cashflow is king. It is very easy to make 25% every two weeks but very hard to make 100% routinely. 25% on $1000 every two weeks for a year is $6500. (without benefit of compounding) Take a profit over and over and over.

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