Four Steps To Trading Success

By: Don Fishback

(Editor's note: Don Fishback is the president of Fishback Management & Research Inc. in Lexington, KY, and creator of ODDS Online software.)

If you are serious about treating your trading like a business -- and you should be because it is -- here are four steps to trading success and how I approach them:

1. Select a stock with opportunity

Use volatility indicators to select a stock that is likely to break out. We are looking for a stock where we can make money in the options regardless of the direction that the stock takes.

  • Look for stocks that go flat temporarily for no apparent fundamental reason. Within two or three months after an active stock goes flat, the share price typically starts to fluctuate again.
  • Use software that allows you to analyze volatility history and options prices, along with free Internet news sources to find stocks where opportunity exists.
  • There are low volatility exceptions. For example, do not use this technique on stocks whose price is less than $10 because the edge you get is too small when the price is that low. The value of an option whose stock is less than $10 will not change that much, even if the volatility changes dramatically.

2. Select the right strategy

You want a simple strategy to exploit the opportunity that exists in the stock you select. The strategies in my arsenal include call and put purchases (directional), call and put debit spreads (directional), call and put credit spreads (directional/volatility) and straddle and strangle purchases (volatility). Strategies more complex than these are poor choices for individuals. For every option you buy or sell, there are margin considerations, bid/ask spreads and commissions.

  • Pick three-month to five-month options.
  • Keep your straddle simple -- use straddles and strangles. If the asset price is in the middle of two strikes, choose the strangle; otherwise, choose the straddle.

3. Select the right entry price

Determine an appropriate price to pay for a strategy that will exploit a stock with opportunity.

  • Use a mathematical method to balance risk, reward and probability properly. Use the Chicago Board Options Exchange option calculator to determine the right price to pay for a straddle.

4. Select the right exit strategy

Look at what prompted you to get into the trade. If you're right and you haven't hit your target, stay in. If you do reach your objective, don't get greedy, get out. If you're wrong, get out!!! Remember, getting out of a trade is what makes you money. This is, by far, the most overlooked aspect of option trading, but it is the difference between success and failure for most traders.

  • Have an action plan and a contingency plan.
  • If things go wrong and a straddle value declines by 50%, exit the trade.
  • If things go right, you can smash a home run:
    • If one of the options hits the purchase price of the whole position, sell half of the profitable options.
    • Use support and resistance to exit the balance of the position.
      Futures trading involves high-risk with the potential for substantial losses