The One Rule You Must Follow When Trading Options

NYSE: SPY | SPDR S&P 500 ETF Trust News, Ratings, and Charts

SPY – When people talk about options trading, the conversation often turns to ultra-risky strategies like buying a call or put options — ahead of an earnings number in the hope of being on the right side. .

When people talk about options trading, the conversation often turns to ultra-risky strategies like buying a call or put options — ahead of an earnings number in the hope of being on the right side. 

The upside in getting lucky on such an unpredictable event is a big, fat profit.

The downside when you’re wrong? 100%. 

As in, the underlying stock gaps against you, rendering the options worthless, and you’ve got nothing left over.

Being wrong on the direction is clearly an easy way to lose money.  But n often overlooked cause of most losses is not having an understanding of the behavior of option pricing. 

One of the biggest mistakes people new to trading options make is not taking into account implied volatility, which is a measure of the expectation or probability of a given size move in a given time frame.  More simply, implied volatility provides a gauge as to whether an option is relatively cheap or expensive based on past price action.  

I can’t tell you how many times I’ve heard people say “options don’t work” because they bought puts or calls ahead of earnings, the stock moved in their direction but the option barely changed in price.  Even when a company such as Apple or Salesforce delivers blow out earnings and the stock pops 10% and 5% respectively, both well above what the options had been pricing in, the profits in buying out-of-the-money calls was dampened by the nearly 50% decrease in implied volatility immediately following the report.  

One could have bought a lower cost spread and achieved the same returns but with less risk. 

The more insidious cause for losses is not grasping the nature of time decay or theta.  Options are a wasting asset. If you buy a call or put outright and the underlying moves in your direction but at a slow pace the option will not gain in value.  

Too many times people turn a position into one based on hope than probability.  It is crucial to choose the right strike, the right time horizon and right strategy that align with your thesis.  Understanding option pricing behavior will allow you to turn probabilities in your favor. 

The less-sexy – but more lucrative — reality is that the best options traders grind out steady profits using a variety of strategies, looking to consistently earn 2% to 4% a month, with an occasional kicker from speculative bets like the aforementioned earnings plays.

2% a month doesn’t sound like a lot, but compounded over a year, it adds up to 27%. That’s more than three times the average historical return for the S&P 500. 

Stretch that monthly gain from 2% to 4%, and the annualized profit is on the order of 60%. 

Most importantly, these numbers shows the power of consistently hitting high-probability singles rather than swinging for low-probability home runs every time we step up to the plate. 

Extreme risk-taking could mean that you’re up 100% one month — and down 50% the next.

You do that, and you’re right back where you started – but possibly with an ulcer and new heart medication.

I’ll tell you right now, the most underappreciated, and in my opinion, the one options trading rule you can’t break is this: 

Never put on a trade that can take you out of the game altogether if it moves against you. 

This is even more true with options than it is with equities because options can move a heck of a lot faster.  

Keep in mind that even my most speculative positions start with defined parameters including price limits for entry and exit points, and a set stop-loss limit order in place once the position is executed unless the risk is particularly.

Why? Because again, I never want to give up my gains – or get knocked out of the game altogether — on one bad trade. I want to keep each and every position on a tight leash so I can pro-actively manage risk, and even increase profitability by adding/subtracting to positions on the fly.  

All positions start with a target price and a stop loss level.   These may be adjusted over time but the risk remains defined. 

This basic rule is your starting point for options trading. 


SPY shares were trading at $299.82 per share on Tuesday afternoon, down $0.93 (-0.31%). Year-to-date, SPY has gained 21.08%, versus a % rise in the benchmark S&P 500 index during the same period.


This article is brought to you courtesy of Stock News.

More Resources for the Stocks in this Article

TickerPOWR RatingIndustry RankRank in Industry
SPYGet RatingGet RatingGet Rating

Most Popular Stories on StockNews.com


Inflation Not Fading Fast Enough for Stock Investors

Investors may have celebrated the end of high inflation too soon. The CPI report shows inflation bouncing higher and thus pushing back the start date for Fed rate cuts. This has the S&P 500 (SPY) coming off recent highs. This begs questions like how much more downside could we see? And when will the bull market get back on track? 44 year investment veteran Steve Reitmeister shares his answers to these questions in this timely commentary including a preview of his top picks to stay ahead of the pack. Read on below for more...

Software Stock Watchlist - Should You Buy, Sell, or Hold?

Rapid growth in the software sector is fueled by increasing digitalization, growing cloud adoption, integration of AI and ML capabilities into software products, and rising cyber threats. So, let’s analyze whether you should buy, hold, or sell software stocks The Sage Group (SGPYY), Qualys (QLYS), and Blackbaud (BLKB). Read more to find out...

Bank of America (BAC) Braces for Earnings - Strategies for Investors

Bank of America (BAC), the second-largest U.S. lender, will publish its first-quarter earnings on April 16. With the bank’s net interest income expected to decline in the first quarter, should investors consider investing in the stock ahead of its earnings? Read on to learn my view...

4 Bullish Airliner Stocks to Consider - Buy or Watch?

The airline industry is well-poised for continued growth thanks to surging passenger and air cargo demand amid rapid urbanization, globalization, and economic expansion. So, should you buy or watch airline stocks SkyWest (SKYW), International Consolidated Airlines (ICAGY), Controladora Vuela (VLRS), and Air Canada (ACDVF)? Read on…

Updated 2024 Stock Market Outlook

The bull market continues to rage on with the S&P 500 (SPY) making new highs. That is the past...the question is what does the future hold? That is why 44 year investment veteran Steve Reitmeister provides this updated 2024 Stock Market Outlook to help you carve a path to outperformance the rest of the year. Read on below for the full story...

Read More Stories

More SPDR S&P 500 ETF Trust (SPY) News View All

Event/Date Symbol News Detail Start Price End Price Change POWR Rating
Loading, please wait...
View All SPY News