From Novice to Pro: A Structured Approach to Mastering Options Trading

Options, as an investment vehicle, is truly remarkable.

Numerous options strategies have been developed, each with its own risk profile, suitable for individuals with varying risk tolerances.

I firmly believe that anyone with the determination can become proficient in options trading, enabling you to implement more sophisticated and effective strategies.

However, it is important to have a well-defined learning plan to help you enhance your proficiency in options trading.

Drawing from personal experience, let's examine the four phases of learning and what you need to pay attention to and become proficient in before progressing to the next level.

Note: This article will undergo updates with additional links and resources as my collection of articles expands. The key learnings are also non-exhaustive and will be continually updated.

Phase 1: Single-Leg Options Strategies

Single-leg option strategies are suggested introductory approach for newcomers to options trading.

As the name implies, it involves either purchasing a single option (long call, long put) or selling a single option (short call, short put).

Favorite Strategy: Wheel Strategy

In my opinion, the Wheel Strategy stands out as the easiest strategy to grasp and implement, given its close alignment with the mindset of investors seeking to buy low and sell high in the underlying stocks.

Here are the steps for the Wheel Strategy:

• Sell a cash-secured put to collect premiums

• If put option assigned, sell a covered call against the asset at break-even price or above and collect more premiums

• Be exercised out of the asset (i.e. selling it away) and restart the process

The goal of the strategy is to regularly produce income and possibly acquire stocks at a reduced price by methodically selling cash secured puts and covered calls.

Key Learnings Before Transition To Next Stage

• Mastering the basics of options trading (knowing how to read options chain, expiry date, options assignments etc.)

• Understanding delta and utilizing it for strike selections

• Understanding implied volatility (IV) and its impact on options pricing

• Comprehend the distinction between European-style and American-style options

Phase 2: Two-Leg Options Strategies

Two-leg options strategies involve simultaneously buying and selling two different option contracts on the same underlying asset, establishing a position with defined risk and reward.

Some popular strategies involving two-leg strategies are spread trades (such as bull put credit and debit spreads) and combination trades (such as Iron Condor).

Favorite Strategy: Put Credit Spread

A two-leg strategy I particularly favor is the put credit spread.

Below is the risk profile of a bull put credit spread.

The strategy entails:

• Selling an out-of-the-money (OTM) put option

• Buying another OTM put option further out

The end result is a defined-risk strategy with a net credit.

This approach is especially advantageous for individuals with smaller accounts, as it enables them to trade credit spreads on higher-quality companies that may be out of reach when selling single-leg options like cash-secured puts.

Key Learnings Before Transition To Next Stage

• Understanding Theta and decay rates of options at different strikes

• Understanding Gamma (the rate of delta change) and Gamma risk

• Observing how the values of long and short options offset each other during market movements

• Learn about position sizing and how to avoid exposing your portfolio to excessive risk

Phase 3: Multi-Leg Options Strategies

In the third stage of learning, we delve into multi-leg options strategies with more complex risk profiles.

This includes delta-neutral strategies such as strangles and straddles, which carry higher risk compared to defined-risk options strategies like credit or debit spreads.

By now, you should possess or strive to acquire the expertise required to perform delta adjustments.

This will allow you to adjust your trades (using combination of puts/calls at various strike prices) to capitalize on various market conditions - bullish, neutral, or bearish.

Favorite Strategy: Put Broken Wing Butterfly

The broken wing butterfly has become a favorite strategy of mine due to its versatility and ability to offer slight downside protection in market downturns.

The standard put broken wing butterfly has the following risk profile.

A broken wing butterfly in constructed by buying and selling options at varying strike prices, resulting in an uneven butterfly spread.

The strategy has the following structures:

• Buying an out-of-the-money (OTM) put debit spread (e.g. $500 long put, $450 short put)

• Selling a further OTM put credit spread (e.g. $450 short put, $400 long put)

Both spreads share a common short strike.

The reason I like this strategy is due to its defined-risk approach and ability to generate profits from minor price fluctuations in any direction.

Additionally, it mitigates or eliminates one side of the risk compared to the traditional butterfly strategy.

Typically, a net credit is received when constructing this position, although there is also the option to open it for a minimal debit in order to capitalize on minor downward shifts.

Key Learnings Before Transition To Next Stage

• Choosing appropriate strikes to create trades that have deltas ranging from negative to positive

• Understanding Vega and its impact on portfolio risk in response to IV changes

• Grasping the Risk Involved for Strangles and Straddles (if you are planning to use these strategies)

• Taking commission costs into account when planning trades for strategies with multiple positions

• Comfortable at managing multiple on-going trades

Phase 4: Utilize Portfolio Margin or SPAN Margin to construct safer profiles

In the last phase, you should be able to use portfolio or SPAN margin to create robust strategies that work well in different market situations, even unexpected ones like black swan events.

Instead of using a single strategy and hoping it will work for most market conditions, you'll now have the ability to decide which strategies are suitable for specific market conditions.

With this level of expertise, you can even create your own options strategies confidently.

When crafting options strategies, the possibilities are limitless.

If you have a particular risk profile in mind, there's a good chance you can construct it using options. It's akin to creating art.

If you possess this knowledge, you likely surpass the knowledge of 99.9% of options traders.

Favorite Strategy: SPX Black Swan Hedges

A black swan hedge is typically constructed using long puts and has the following risk profile.

As the market crashes, the value of your long put will increase rapidly.

Moreover, the T+0 line's slope will steepen even more as IV explodes, driven by the positive Vega associated with long puts.

What's the rationale behind implementing a black swan hedge in the context of portfolio margin or SPAN margins?

Since portfolio and SPAN margins utilize risk-based methodologies for determining margin obligations, they usually demand less margin under typical market conditions.

In times of market crash, the IV can quickly spike, leading to a significant increase in margin requirements.

This surge could potentially prompt margin calls if appropriate protective measures are not implemented.

Thus, setting up black swan hedges is vital to safeguard your portfolio against such catastrophic occurrences.

Key Learnings In This Stage

• Understanding the main distinctions among Reg-T, portfolio margin, and SPAN margin

• Discover the unique trade profiles achievable solely through portfolio or SPAN margin, and leverage them to craft trades with safer risk profiles

• Consider the overall portfolio risk rather than focusing on the risk of individual trades

• Determining optimal black swan hedge to avoid overpaying premiums while securing your portfolio