Options trading is often seen as riskier than regular ownership of company shares, but this is only because options grant cheaper exposure and greater maneuvering space through hedging. At the cost of an option premium, traders can not only gain exposure to the stock but gain leverage to amplify gains.

Yet, this same flexibility opens up the potential for huge losses. A time constraint via expiration, rendering all options eventually worthless, places an urgency on the trader’s action plan. And herein lies the danger. Without a clear plan and a set of goals, it is easy to stumble across tripwires.
 

And what is the best way through a minefield? To have the right tools, discipline and clear strategy. For successful options trading, this entails adherence to a routine. One that is formed if we examine the following guidelines.

Setting Clear Goals and Defining Your Strategy

From protective puts to covered calls, options provide many strategies to safeguard existing stock portfolios. But does your goal revolve around mitigating losses or adding extra income generation into the trading pipeline?

By sticking to a clear strategy with a specific purpose, you set boundaries for action. These boundaries then have the effect of mitigating the downsides of options trading. Let’s take a look at straddle strategy as an example.

• Taking in macroeconomic data and market sentiment, a trader becomes convinced the price of an underlying asset will become more volatile.
• The problem is, the trader can’t decide in which direction the price will move.
• In this scenario, the trader would deploy a straddle strategy by simultaneously buying a call and a put option with the same expiry date and strike price.

This way, the trader intentionally decides on a tradeoff. Obviously, buying both call and put option contracts is more expensive than buying one of them. In turn, the price of the underlying asset would have to move significantly to offset the expenditure.

At the same time, straddling divides the risk in both directions. And the initial expenditure of options represents the maximum risk exposure while there is a substantial upside if the price moves in either direction.
 

But what if a trader considers this strategy too conservative? As timed contracts, options require precise timing that is often difficult to pinpoint. In that case, a long straddle strategy would be in order as the default - purchasing both call and put options at-the-money or near-the-money, where strike price is close to the current price of the underlying asset.

In contrast, a short straddle strategy would be far riskier. In this scenario, a trader would aim to profit from low price volatility of the underlying asset, by selling call and put options with the same strike price and expiry date. But this opens the exposure to unlimited risk because a significant price move, up or down, would force the trader to sell at the strike price.

Moreover, a short straddle would also deliver limited profit potential because it is contained to combined premiums from selling calls and puts. Of course, if proven correct by having the underlying asset stay in the same narrow price window, a short straddle can generate more profits than a long straddle.

In that ideal scenario, neither put nor call options would become in-the-money. In turn, the trader would get to keep the full premiums collected when selling the options.

In other words, options traders must identify risk at the staging point. Is the selection of a trading strategy itself riddled with a bias? If so, this bias should be examined to full extent. If confidence in this scrutiny is lacking, it would be better to prioritize low risk over high profit potential.

By doing this routinely, traders will inevitably reveal their risk preferences and implement appropriate strategies that fit that profile. 

The Role of Education and Continuous Learning

The key to proper scrutiny, and then selecting proper options trading strategy is to be aware of the unknown unknowns. Or, as the Secretary of Defense Donald Rumsfeld noted in 2002:

"There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don't know we don't know."
 

Although Rumsfeld coined this wisdom for the purpose of a military operation, it applies even more so for options trading. It is fair to say that the market is far more complex than any large scale military engagement. 

After all, option contracts themselves are an abstracted economic layer, on top of the already abstracted layer of ownership via company shares. Not to be discouraged by this complexity, options traders should instead embrace it and focus on continuous learning. 

Only by learning about market trends, new strategies and risk-mitigation techniques can unknown unknowns be reduced to a minimum. And as long as this space is contracting, traders should be on the winning side of trading.

This is why major financial platforms regularly host educational content that should be visited. For example, Charles Schwab has a regular options market update to inform on day-to-day market sentiment.
 

Above all else, such updates are critical to gauge the market, as an aggregation of sentiments and monetary policy effects. Likewise, market updates provide macro insights on volatility of fundamental assets like WTI Crude Oil and the CBOE Volatility Index (VIX) itself as market’s fear gauge.
 

Just by observing daily market updates before committing to an options strategy, traders can learn what to look for and how to respond. 

Developing a Consistent Research Routine 

While daily market updates from reputable financial firms are important, how to put them to good use to maximize options profits? In short, it all comes down to the visualization of market patterns.

Otherwise known as technical analysis (TA), traders use a wide range of tools to analyze trends on a minute level to gauge market sentiment that may affect their options trading strategy. Within the TA domain, the most common routine is to identify upward or downward trends via moving averages. 

Whether simple moving average (SMA) or exponential moving average (EMA), they help identify the timing of the trade by aggregating price averages over a time period. Case in point, EMA is particularly useful because it gives more weight to recent prices. When deciding to go bullish (calls) or bearish (puts), the asset’s price above EMA would signal an uptrend while under EMA would point to a downtrend.

Honing on this further, traders could use crossover strategy by comparing two EMA trends, such as 12-day vs 26-day. In turn, the shorter EMA above long-term EMA would signal upward momentum, weighing on the side of call options.

But this is just the beginning of a research routine. In conjunction, candlestick patterns could reveal market reversals or continuation of trends. Likewise, bollinger bands give insight into volatility by showing lower and upper price bounds, which could point to potential price breakouts.

On the market sentiment side of research routine, the Chicago Board Options Exchange (CBOE) regularly issues companies’ put/call ratio (PCR). By dividing the total volume of put options with the total volume of call options, traders can interpret this data as leaning more bullish (under 1), bearish (over 1), or neutral (~1).

Is a consistent research routine time consuming? Yes, absolutely.

However, it is more important to spot trading thesis failures. This would be the opportunity to bring out the unknown unknowns to the light, by either adding more TA tools to the repertoire or revisit the understanding of existing ones.

Only in this revision process is a robust research routine established, preferably with demo accounts first. Keeping such a journal is easier than ever with document automation software.

Tracking and Analyzing Performance via Alerts

Alongside becoming familiar with various TA tools, it is equally important to systematically track successful and failed trading strategies. It is particularly vital to examine successful outcomes because they may be flukes. And if these assumptions (under false rationale) are then carried over, they will yield failures.

In contrast, failures are typically easier to unravel. Fortunately, online platforms have greatly automated this process, supplying options traders with useful performance summaries, data analytics, and real-time alerts. The aforementioned Chalres Schwab platform even provides risk/reward visualization and probability metrics for options to finish in-the-money.

Traders should also count on services that provide options trading notifications, such as price changes or market-moving news, to stay on top of quickly changing trends in the options market.

Timing and Execution—The Final Key to Success

Given that expiry dates are embedded into options trading, all such contracts become worthless. Although profits can be gained from time decay and volatility, it is preferable to rely on trades around expiry dates.
 

Foremost, options traders should outline clear market entry and exit criteria based on certain signals (news) or conditions. This also includes setting stop-loss levels. If the confidence in a certain strategy is high, it would be useful to take advantage of bots to automate trade executions.

Conclusion

In the end, options traders should avoid “gut feelings” because this is not data that can serve as an extrapolation resource for future setups. If a gut feeling is in play, that typically means the lack of understanding of the picture that TA tools have painted. Rather, the focus should be on a systemic approach that utilizes proven tools, market signals and actionable market updates in synergy between each other.

Demo accounts should be prioritized to first engage in backtesting and forward testing of strategies, without the risk of losing funds. This is the first stepping stone to building confidence and experiment until a suitable trading strategy is found.