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How To Trade Opportunity

Options trade in multiple price dimensions. Time spreads get cheap or expensive and skew steepens and flattens. Implied volatility rises and falls. Before you enter a trade, there are a number of factors to consider. And as always, if you have questions, please speak to a financial advisor or other professional.

  • LIQUIDITY

    • The LIQ Index tracks liquidity because it is the most important factor to consider when trading. Liquidity is what gets you the best price on entry, and the ability to close your trade on exit. 

    • Liquidity is demonstrated in markets that are both tight and deep. Tightness refers to the difference between the bid and ask spread, and depth refers to the size displayed. ​​

  • EXTREMES

    • A stock that has fallen 90% can still fall 90% again. Putting on a position when a value, level, or spread has hit an extreme often looks like a good opportunity, but it can always extend further. 

    • Volatility might be mean reverting but it is often a choppy ride down. 

  • KNOW THYSELF

    • Every trader is different, and your strategy must reflect this. If you can’t sleep at night, or regularly close out early, you’re taking too much risk. 

    • If you are a detailed oriented trader, focus on exploiting opportunities like mispricing or arbitrage. If you have a strong fundamental background, use options to leverage your position and manage risk.

  • WORST CASE

    • Always pay attention to the worst case scenario. Using spreads helps keep risk bounded and defined. The worst case scenario happens more than you want it to, and the best case far less often. 

  • SIZING

    • Position sizing is as important as pricing. Your size should represent not only your confidence in the trade, but your ability to withstand a loss or drawdown. 

    • Preserving capital to trade another day is an absolute priority, and bad sizing is the fastest way to lose this.

    • Metrics like the Kelly (or half Kelly) criterion are useful to frame the question, but also recognized as simply an estimate. The real world is path dependent.

  • DURATION

    • The duration of your trade should be a reflection of your thesis. Longer term trades have more time to go right, but also to go wrong. 

    • Be sure to have enough capital to float the trade for the entire duration, and not be forced out for early closing. 

  • EVENTS

    • Events are a double edged sword when trading. Volatility is typically elevated around expected events like Fed announcements for macro news or FDA approval announcements for pharmaceutical stocks. This makes it more expensive to buy options, and riskier to sell them. 

    • Earnings tend to bring significantly higher volumes and tighter spreads, which can be good for entering a position, but traders must also be aware of the volatility crush and reduced liquidity afterwards. 

  • GREEKS

    • Understand all the dimensions of your trade, as risk can sneak in from many angles. A time spread can be a bet on the implied volatility difference between two months, but if constructed using only calls or only puts it also represents a directional bet.

    • There is no such thing as a risk free trade, but a well constructed position seeks to isolate a single factor and limits the number of ways you can lose. 

  • ALWAYS BE CHANGING

    • Edge is ephemeral, and the markets are constantly adapting. The best traders observe as these dynamics shift, and adjust  their strategy. 

    • There is no recipe for success, but the process of reviewing and refining your technique supports continuous improvement. 

  • OBJECTIVES

    • Your trading strategy should reflect your goals. Beware of taking too much risk with money you need in the short term. Conversely, taking too little risk on long term investments may create a shortfall.

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