Let's start with what their secret is not. Contrary to popular belief, successful option traders do not build their careers on being right all the time. In fact, the issue of being right is kind of secondary to a seasoned trader. Smart traders know that of the thousands of trades they'll have in their careers, they'll have plenty of winners and plenty of losers. So they position their trades accordingly.
Successful traders are great option strategists. They structure trades right from the get-go to optimize the delicate balance of chance of success vs. payout structure. They take into account all the pricing influences that can affect their trade--namely: direction, time and volatility. They protect themselves by using limited risk; and they squeeze the most out of their winners.
Each different trading opportunity is unique and may require a unique and specific way to trade it. For example, lately the market has been highly volatile and implied volatility has reflected that in most option classes. Much of the time, I've been using debit spreads (and credit spreads too) on my directional trades in which I expect limited moves instead of outright call or put purchases. Why? Hedging. Debit spreads hedge off total capital at risk by making the overall cost lower. Further, they hedge off implied volatility risk by having one long-vega option and one short-vega option.
For example, imagine a trader is looking for a continued rally in Amazon.com (AMZN - Get Report) up to the $230-a-share area by October expiration from its recent price of $226.78. At first glance, one might consider simply buying, say, the October 225 calls for $11.10. The challenge here is that if the trader holds the trade until October expiration and AMZN actually gets right up to $230, the trade ends up a loser! The breakeven is $236.10 on the trade ($225 stock price plus $11.10 premium).
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