Option Trading – How to Develop an Option Trading System

There are four stages to any option trading system: selecting the stocks, option selection, and the entry and exit procedures. Option trading can be approached either as a discretionary or a mechanical trader.

The discretionary option trading system does not follow any particular rules. The trader relies on their gut, doing what they feel is right at the time. They choose a trade, and decide when to enter and exit based on their own knowledge and experience.

A mechanical trader follows a pre-determined process using all their knowledge to create an objective set of rules to govern all stages of trading, from the choice of stocks to entry and exit. These rules are often laid down in a computer software program that will make the process as automated as possible. Mechanical style traders remove the influence of human emotion on their process, thus reducing human error. In order to develop a mechanical system, all stages of the process need to be carefully considered.

First you will need to make a list of all the quantifiable criteria that can be used to judge whether a stock would be a good candidate for options trading. They need to be quantifiable so that you can chart them on a computer, enabling all qualified stocks to be automatically identified every day. This will significantly reduce the amount of time it takes to identify qualifying stocks. Using quantifiable features also prevents you from relying on your own judgment. The sort of criteria you should consider include a last close of at least ten dollars, last price rising over the last three days and having a PE that is positive. Using the criteria is how you would choose which stocks to watch.

The second stage is to decide which options will qualify for your trading system. This will depend on what you want to base your system on. You could use ITM or OTM options, or base it on bearish or bullish spreads. Whatever you decide on is how you will choose the option to buy for the stock chosen in the first stage.

Third, you need to determine the conditions under which you will actually buy. There are a number of different entry procedures that can be used. You may decide that it is best for you to buy at the opening of the market, or that you need a more complicated procedure which could involve watching the movement of underlying stock for a specified period of time before it meets the conditions for entry. Design a process that fits with your own style of trading. This process is how you will use to decide when to buy.

It is always best to learn as much as you can before jumping in. Start small while you get the feel of trading. That allows you to minimize losses during the learning curve.

Leave a Reply

Your email address will not be published. Required fields are marked *