Stock market trading, directories, news, articles, trading systems, stock market trading, technical analysis, options

SML - Stock Market Directory

Options Investing Strategies

By: OTS Team

Article Category: SML Options Trading

It is very important to understand how to invest in options before starting to trade them. Many options traders loose a big portion of their portfolio when they start to trade options simply because of the wrong “selected money management strategy”. Money management options trading strategies dictate how much to invest (and reinvest) in each trade. We have compiled three of the most popular investment strategies below with explanations of how these strategies are applied in the options trading.

Strategy 1: Invest a fixed percentage of the portfolio

One of the most popular trading strategies is to invest a fixed percentage of the portfolio on each trade. In a simple example, when a trader dedicates 20% of a portfolio in each trade, and assuming a $10,000 portfolio value, the trader would thus invest $2,000 in the first trade. If a first trade results in a 50% profit, the portfolio then would grow to $11,000 and in the next trade $2,200 (20% of $11,000) will be invested. This approach to options trading is considered conservative and is very often used by professional options traders.

Strategy 2: Invest a fixed amount

Another investment strategy is to invest a fixed amount per trade. Similar to the first example a trader would initially allocate $2,000 in each trade. Even after the portfolio grows to $11,000 only $2,000 would be invested in the second trade. This trading strategy is less profitable than the first investment strategy discussed above; however, it allows a trader to recover more quickly from a losing trade. In some cases this trading strategy can be used in combination with strategy #1 by options traders. For instance, in order to increase profits, some traders may prefer to use strategy #1 after each winning trade, and in order to recover faster from a lost trade the #2 strategy might be used after each lost trade until the portfolio is restored.

Strategy 3: Reinvest both the principal and the accrued profits

The last popular trading strategy involves the reinvestment of both the principal and the profits after each trade. If a trader invests $2,000 on a first trade and then takes a 50% profit, then $3,000 would be invested in the second trade (the principal of $2,000 plus the $1,000 profit). By using this strategy, a trader would benefit from compounding and many investment institutions use this strategy, however, trading options this way is aggressive and very risky and may quickly result in wiping out an entire portfolio. None of the professional options traders use this strategy in options trading.

In summary: Options trading is a very risky type of trading and using the strategy #3 could be equivalent to financial suicide. Sooner or later a trader using this strategy will result in loosing the whole portfolio unless a 100% successful options trading system is used. On the other hand the options trading strategies #1 and #2 are used most of the time. Strategy #1 is used in autotrading by many online brokers and very often this is the only choice a trader has in the options autotrading account.