How I Construct Options Trades

In this post, I will explain how I actually build an options trade.

One of the unique characteristics of options compared to stocks is that you can continue to tune the risk-reward profile from the moment you start building a position, while opening a trade, adjusting it halfway, up to when you close it.

Constructing a trade has everything to do with the risk-reward characteristics of such a trade: like selecting the right group o assets, the underlyings, what options strategy you are going to use, what the contract duration will be, which directional assumptions you hold, the chosen delta, etc.

Each trade should fit my personal goals, my entry rules, and whether or not it is complementing other positions I have (buying power and portfolio allocation based on VIX, beta-weighted delta etc.! ).

As with most of my other rules and principles I use in options trading, much is based on the brilliant book by Tastyworks‘ Julia Spina The Unlucky Investor’s Guide to Options Trading.

The Unlucky Investor's Guide to Options Trading

I follow their procedure to set up each trade and select in the following order:

  1. An ‘asset universe’
  2. An underlying (symbol)
  3. A contract duration (mainly 30 – 60 DTE)
  4. A defined or undefined risk strategy
  5. A directional assumption
  6. A delta
  7. Each of them will impact the success of my trade.

1. Asset Universe

The best underlyings to trade with are optionable stocks, ETFs, or indexes that have all or as many as possible of the following characteristics traded in highly liquid options markets (that is: easily convertible into cash without affecting the price).

I aim (following Julia’s Unlucky’s Investor) at selecting both:

  • High liquidity of underlyings with:
    • a high daily volume of > 1 million shares/ETFs traded daily
    • Tight underlying bid-ask spreads: not more than 0.1% of the asset price as the difference between what the buyers are willing to pay (bid) and what the sellers are willing to accept (ask).
  • High options liquidity with:
    • Flexible/multiple open interests or volume across strikes (>100 per strike)
    • A tight bid-ask spread <1% of the contract price
    • Flexible /multiple strike prices and time frames/expiration dates (also for managing positions!)

This ensures a wide selection of choices and more possibilities to adjust positions when needed, so the risk of being stuck with a trade is lower (closing short premium positions).

My ‘asset universe’ consists mainly of equities and ETFs. I call it my ‘faves’ and follow them in Tastyworks, and my watchlists in BarChart and TradingView.

My Faves

2. Underlying

3. Contract Duration

4. Defined or Undefined Risk Strategy

5. Directional Assumption

6. Delta

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