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Chapter 6. Eight winning option trading rules > There is a time for all seasons

4. There is a time for all seasons

This means you need to have a feel for market conditions prior to implementing any option strategy. I've known traders who have initial success with one or another strategy and think they've found the Holy Grail. I met a doctor who was lucky enough to turn $5,000 into six figures during the bull corn market of 1996. His first trade was a long shot that worked—the purchase of deep out-of-the-money calls for March that turned deeply in the money by expiration. He took his profits and rolled them into at-the-money Mays that also eventually went deeply into the money, then once again into Julys, and that worked, too. He caught the best kind of market for this strategy and then proceeded to give all his profits back in a dull period in a variety of flat markets. I've also seen people win 9 of out 10 times when selling out-of-the-money calls only to fall flat on their faces later. In the early 1980s, a firm called Volume Investors became one of the largest option players in the gold pit by continually selling premium. It worked beautifully for years, but it took just one unexpected, yet volatile spike to wipe them out—to the tune of $6 million. The lesson: Know your market. Option writing can be extremely profitable in dull, flat markets. If the tone changes, cover fast before that catastrophic loss. If option premiums feel too low to give you an adequate cushion of income, they probably are. The common wisdom is to “sell flat markets,” but I suggest this is just the time to start thinking about buying. Avoid selling in periods of rising volatility. Option purchases will start to become more expensive, but then the rising volatility will work in the buyer's favor. Only when volatility reaches wild proportions should you think about selling—just make sure you're adequately margined to take the heat.


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