Checklist for Trading Options: A Comprehensive Guide for Decision-Making

Trading options can be a complex and dynamic process, requiring a thorough checklist to ensure optimal results. This article breaks down the key considerations and data sources for making informed options trades.

General Conditions for All Option Strategies

Before executing any options trade, it's essential to adhere to a structured checklist that covers general conditions applicable to all strategies. This ensures a consistent approach and mitigates potential risks.

Defining Rules: Always keep your defining rules in mind. For example, do not sell options for less than $0.50. Expiration Dates: Preferring shorter-term options (front month or weeklies) due to the largest theta (time decay) slope from 18-22 days to expiration. Liquidity Assessment: Measure the bid-ask spread, expecting to pay at least 50-100 of the spread. Volume and Open Interest: Use front month ATM (At The Money) puts and calls to measure this. Richness/Cheapness of Options: Evaluate using the past year of daily closing front month ATM implied volatility data. Also, consider the past year of daily front month ATM implied vs. 20-day closing historical vol ratio (implied/historical). If the option is rich to historical or cheap to historical, use these measures as guiding indicators.

Specific Considerations for Different Trades

While the above checklist covers general conditions, specific trades may require additional considerations. This section delves into specific scenarios and the tools to evaluate them.

1. Selling Call or Put Spreads: The short leg typically represents the ATM option, but sometimes it can be the first strike OTM (Out-Of-The-Money). Use the SKEW (Skew) index to assess the potential impact of owning the OTM option, which may have a higher IVOL (Implied Volatility). The SKEW does not need to be flat, but a lower-end of the band is preferred to ensure a high probability trade.

2. Trade-Specific Data: Understanding the specific circumstances of the trade. For example, if you're using options to hedge a position, or if you're speculating, there are different factors to consider.

Data Sources for Option Trading

Access to reliable data is crucial for making informed decisions. Here are some common sources and best practices:

Stock Options Analysis and Trading Tools: Utilized as a pay service for comprehensive analysis and trading tools. Ensure the data is accurate and free of obvious errors. Self-Collection: Manually gathering data can be accurate but more labor-intensive. This method provides complete control over the data quality. Broker Offerings: If your broker offers free data, this can be a cost-effective and reliable option. Data Quality Assurance: Regularly sweep the data to check for inaccuracies. If using third-party sources, ensure they are trustworthy and provide a robust data quality control process.

Conclusion

Trading options requires a meticulous approach, from defining rules and evaluating liquidity to assessing the richness/cheapness of options and using specific tools for different trades. By adhering to a well-structured checklist and using reliable data sources, traders can make more informed and profitable decisions.