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The quest for the Holy Grail

As an options trader with a pretty good imagination I continually look for the trade that can’t lose money. Based on emails I get and conversations I have, I’m not the only one.

For many, the Holy Grail starts out as naked puts on high dollar equities like ISRG, AAPL, GOOG, MA, PCLN and others I’m sure. Many people have indicated to me that they have given it a try. All of those people confess that they have lost far more than they have made. The naked put is placed so far out of the money that they think the equity will never get there. One of the challenges of the Holy Grail is that it works great until it doesn’t. You see the money rolling in and feel justified in risking more and more. Then when it doesn’t work, there is so much risked that the loss wipes out any previous gains. Typically it seems they see the loss coming but just can’t believe the equity will get there so like a deer in the headlights they wait too long to adjust into a trade that could be profitable.

It seems like many options traders go through this “phase” of thinking that the naked puts or bull puts are the answer to endless fortunes. Recently a friend told me that his financial advisor was doing this in his account. Pretty scary stuff to me. What is a common adage of the market? Sell in May and go away? They are not talking about naked puts. Unless they mean sell in May and go away, penniless.

The bull put can be a very nice profit generator but you need to consider the equity’s price movements. If it drops in May with the market then bull puts aren’t a great trade during that drop. Bear calls would be the credit trade of choice for drops. So Sell in May and make some Hay means using bear calls not bull puts for the drop in May. Of course bull puts can work very well as part of a trading plan.

Bull puts work if an equity goes up or if it stays above the short put strike. Bear calls work in a similar way, if the equity goes down or if it stays below the short call strike. The more accurate you can be, the higher the return. But if you are wrong, the greater chance you’ll take a loss. So don’t get too greedy or over confident and you’ll have some room to adjust the trade if you are wrong.

If you can find an equity that moves predictably and has reasonable credits, that is the beginning of finding the Holy Grail. Next you need to make certain you know what you are going to do if the situation changes and your trade is failing. Then you need to look for another equity that moves differently than the first. The goal is to have one trade work even if the other is challenging.

I think I’ve found my Holy Grail. My Holy Grail is a group of equities that move very differently, are predictable and have really good option chains. Option chains are my tools and charts are my crystal ball. I look for patterns that repeat and work well with the option chains. I look for trades that give me a high probability of success with the patterns. I look for capital efficient trades that return a good reward for the amount of confidence I have in the pattern. The more confidence I have in the pattern, the higher the return that I go for. I keep the number of equities I trade to a relatively small group. Turns out the most successful investors do the same thing. They concentrate on a few companies that are very high quality. They buy large shares of those companies and hold them for life. I concentrate on a few equities that have quality options and patterns. I trade them for a long as the patterns and the option chains hold up. Over the years I come up with better and better entries, exits and trades, raising my return each year. This allows me to increase my return without risking more money.

My Holy Grail fits my trading style, the time I have and my portfolio goals. It evolves over time to improve my risk/reward ratio. You can develop your own Holy Grail. It just takes some time, option knowledge and a little imagination.

Ken Bailey
OptionsANIMAL Instructor

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