Is having a mental trading plan good enough? This article will argue that it is better to have a WRITTEN trading plan than to just have one in your head. The way I handle my trades is quite primitive. I do not use fancy electronic screen prints because after a while, there are tons of electronic files left to look at; I simply use index cards. On the front side, I record my entry and on the back, the lesson learned after exiting.
I suggest that novice option traders go out and buy a deck of 3 x 5 index cards and write the current price of the underlying on the red line. Below the red line, they can spell out in a simple sentence the reason for either a long or short entry. On the lines below that, name the option strategy applied, together with the worst possible outcome (stop being hit), option premium cost at the entry and lastly target, or best possible outcome. Having the stop, entry, and target spelled out on a tangible index card is very helpful because it can be easily carried around.
The card should also specify which account the trade was placed in, which is quite essential if a trader calls the trade desk and has several accounts such as an IRA, a Coverdell ESA, or a Joint Account.
As an example, I will share one of my most recent trades.
Figure 1 shows the daily chart of the exchange traded fund (ETF) that tracks the Dow. There were three steps that I went through before I made my decision to enter the trade. The first step was FA (Fundamental Analysis), or as I like to call it, "what" to trade. We can assume that the Dow Jones Industrial Average's ETF is not going to get delisted from the exchange for the duration of my trade.
Hence, the first step gets a passing check mark. The second step is always TA (Technical Analysis) or "when" to trade; in other words, the timing of the trade as well as the direction of the trade. As can be seen on the chart (Figure 1), there was a drop that was followed by a base building, and on Friday, a higher high (marked on the chart as HH) and higher low were created. The DIA closing price on Friday at 1 PM Pacific Time was at 112.80 which is also spelled out on Figure 1. This analysis helped me to create a short-term bias to the upside, so check mark for TA.
However, it was the third step, IV (implied volatility), that helped me to decide "which" option strategy to take. The equation is simple: If the IV is high, then be a seller of premium. The chart was telling me to be bullish, short-term, and with the higher IV, I had the choice between a cash secured put and a short vertical, so I chose the latter one. The exact data that I entered on the index card is spelled out in Figure 2.
Observe on Figure 3, which shows my broker statement just for the DIA trade, that I had sold the DIA put spread when the market was officially closed. The DIA option contracts are being treated as cousins of the Futures contracts, thus they trade an additional 15 minutes after the bell. It might sound crazy, but I was trying to squeeze as much credit for the Bull Put spread as possible with a single contract on Friday afternoon after the closing bell. After I was filled on a single contract at 13:08 PM PST, I sent the troops, the other nine, and was filled at the same credit a minute later.
Basically, my logic was simply to sell premium over the weekend and to close the position by buying it back for less. Figure 2 shows the maximum profit calculated at 0.22 per contract, but that would be if the spread was held all the way until expiration. With all the economic announcements around the corner such as CPI (Consumer Price Index) and PPI (Price Producer Index), as well as unemployment numbers, I did not feel comfortable holding it until the end.
The exit chart, Figure 4, also shows a technical reason for exiting. Notice that the price action of Monday was significant to the upside; therefore, the value of the put options had decreased. Also, the DIA has parked itself right below the resistance at 115, so once again, I had to ask myself a hard question: Does it make more sense to hold open the Bull Put spread when the price action might go lower and risk what was already gained, or simply take the money and move on?
Figure 3 already declared my action, yet Figure 5 shows the exact contracts involved and the time of the transactions. Both of these trades went to COMBOX and were filled by PSX at 12:58 PST.
By closing the whole spread for 10 cents per contract and paying the exit commissions on both legs, I did not make the max profit of 22, but did make about half of it. Moneywise, it might seem that I have short-changed myself, but time-wise, the story is quite different. The trade lasted only one full trading session and made half of its max profit. The very next day, DIA headed lower, but I did not have to be concerned because I was no longer in it. This is what I entered on the blank side of the index card.
In conclusion, this article has argued for the importance of defining the trade in as many details as possible prior to entry as well as writing it down. By having things written down, an official record of our thinking is created before entry, leaving us with a specific plan. After the trade is over, we can easily examine what could have gone right or what could have gone wrong in case the trade did not work out. Have good trading.
Source: http://www.fxstreet.com/education/related-markets/lessons-from-the-pros-options/2011-08-23.html
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