Options strategy selection hinges on the desired outcome and expectation for an underlying asset. Specifically, what is our target and how does the underlying help us achieve that goal. Also, for this to be efficient the trader will require an understanding of basic options strategies.
Option strategy selection is virtually limitless, in that, there are so many different ways to trade options. However, if you’re able to answer the two primary questions of, what and how, the actual strategy selection becomes much easier.
Key Criteria for Options Strategy Selection
- Underlying assumption
- Probability of Profit
- Position Size
- Time Horizon
Simply, what do we think the asset will do next. Worth noting, is the importance of implementing strategies that allow for profitability when assumptions are incorrect.
Probability of Profit
The possibility the trade will become profitable at expiration. A mathematical expression typically notated as a percentage to underline the likelihood a position will become profitable.
Position sizing is strongly tied to capital allocation. As a result, we’ll use this section as a breakdown for each OptionID’d within the boundaries of our capital allocation allowance. Further, position sizing is the number of contracts traded within one position.
How quickly we want to or could potentially achieve our profit target. Furthermore, selection of an appropriate time horizon can make or break an option trade. Moreover, in the absence of a clearly defined end point we’ll err on the side of more time, to allow for our desired outcome.
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