One of the most basic option trading strategies is to sell a credit spread.  This is usually done whenever the trader has an opinion on a stock or other underlying issue that it is going to go up or down in price, in a certain period. For instance, let’s suppose APPL was trading at $106 per share and you thought that APPL would stay above 100 for the next few months, you might sell the December APPL 100 Put and then buy the December 90 Put; thereby creating a credit spread, because the 100 Put you sold would be more valuable than the one that you bought at 90. As long as APPL stays above 100, the duration of the trade, that is until December expiration, you will be profitable . You have time decay on your side in this trade, that is, it’s positive theta. Each day that passes by, the short you sold is worth a little bit less in time value. This is how you make your profit over time.

Often the difficult part of this type of strategy is the management plan. What do I do if APPL does drop in price towards our below $100? One strategy that you can utilize is using your P&L percentage of profit, or percentage of loss, as your guide to either make adjustments to the trade or to close the trade. For instance, you could use a guideline: If the trade is up 10% on profit, I will close the trade or close half the trade and maybe let the rest go for higher profit. And conversely, if the trade is down 10%, I will close half the trade or even all the trade. This type of risk management will prevent you from just staring at the screen while APPL goes down further and further and your loss deepens. Of course, the percentages you use are up to you and what works with your portfolio level and your level of conviction of APPL’s movements. Always have a plan such as this, though, that prevents catastrophic losses or at least losses that outpace your gains from previous trades.

Mark Fenton- Senior Mentor at Sheridan Options Mentoring

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As traders many times we tend to only look to the short term and what trades we have on or are about to enter. To be successful with any longer term goal you not only have to know where you are headed but how best to get there. Having a plan and setting mile posts to mark progress along the way is fundamental to a successful trading business.

First, we want to determine our long term goal. To give two trading examples perhaps you either want to generate a certain monthly income or build a certain dollar value in your account. Whichever of these you choose, it is important to set a monthly goal to track how you are doing in reaching the goal. That way if things are getting off track you can address any problems before you get too far off your success path.

Secondly, setting realistic goals is key. Let’s say for instance that you want to generate a monthly income of $5000. If you are trying to reach that amount using a $100k account size, it will be easier than trying to reach it with $20k account size. A simple illustration to understand is: The lower the percentage of your return on capital you require, the easier it will be to succeed. So be realistic in what you set for goals to give them a better chance of attainment.

Finally, what trading strategies and portfolio allocation of them will I use each month? With option trading you can utilize both monthly and weekly option expiration chains in your plan. You may for instance want to do a weekly calendar or butterfly as well as a monthly calendar or butterfly and also employ iron condors, etc as part of your over all strategy.  Try to have a mixture of these strategies each month to take advantage or hedge the changing volatilities in the marketplace.  To properly understand and have good risk management, as well as deployment of a plan, you will find that proper education from an experienced mentor and trading education program can help reduce your learning curve and give you better accountably in your trading business. Taking advantage of the trial and error that another experienced trader has been through, helps you avoid many pitfalls traders often fall prey to. Putting all of this together is what separates the successful trading business from the failed one.

Mark Fenton
Senior Mentor