Spread Trading: An Introduction to Trading Options in Nine Simple Steps

CHAPTER 22

Did You Know that You Never Want to “Make As Much Money As Possible”?

“First, Shorty, I want to address something you just said. You said that Lon is trying to make as much money as possible on his long calls and puts.”

“Yes, that’s the way it seems to me,” answered Shorty.

“Yeah, me too!” exclaimed Lon.

“Unfortunately, that’s exactly how you go broke in the market. Your goal is NEVER to make as much money as you can on any one deal. Think about it, Lon. Suppose at the end of a month you happen to be up 20 percent on a long call on Plum. Suppose you paid $6 for it, and now you could sell it for $7.20—a 20 percent return. What should you do? Should you hope it just goes up more and wait for that to happen? That’s tempting, but what happens if the stock goes down and the value of the option goes down? Suppose you end up out of the money at the end of the expiration period, so you’re forced to just let the option expire worthless? Then Shorty gets to keep the debit you paid and you get nothing! How does that 20 percent return on investment look to you now?”

There are a million deals out there. It’s far better to make a lot of 20 percent deals than to hold out for one or two big payouts.

“So here’s the deal,” Aaron chimed in. “You never make a deal—on a trade like this long call we’re discussing—unless you decide in advance the percentage profit you want to make on it. Then, when you reach that percentage profit (and it should always be something reasonable like 20 to 25 ...