There are two types of people in this world, those that categorize people and those that don’t.
I roughly categorize options traders based on their Greek-focus (whether they are conscious of their bias or not):
- Beginner – delta
- Intermediate – theta
- Advanced – volatility (~Vega)
The novice trader is introduced to buying calls if they think a stock will go up or buying a put if they think the stock will go down. These are directional bets and easiest to understand, particularly if the trader is familiar with buying or selling stock. The focus of this trader is often on delta.
One of the most common questions from this type of trader is “I bought a call before earnings, my stock went up after earnings -how come I lost money?”
Sick of losing money on OTM call options going into earnings or their longer term trades slowly bleeding money, traders learn about selling options. Since they were often burned by Theta, all they need to do is sell options to make enormous profits.
This trader focuses on theta – selling as much time premium as possible.
This trader quickly learns about gap risk if selling naked (the options, that is). Ideally they quickly learn to sell risk defined trades or decrease their position size.Many questions arise like “how did I lose so much if the trade had a 90% probability of success?” Or “it worked 5 times in a row, so why is my broker asking for money after I placed my entire account in TSLA short puts?”
Note that this trader can often be profitable if they maintain a risk defined approach and limit their position size. Especially in low vol environments or the amazing bull run we’ve had for over a decade. When conditions change (see financial crisis or even parts of 2018), this trader is often surprised that their mechanical approach no longer works.
The more advanced trader recognizes the pitfalls of the beginner and intermediate trader, and takes a more holistic approach to trading – considering all of the Greeks.
This trader often starts with a volatility viewpoint – recognizing the current market conditions and selecting trades based on it. The advanced trader realizes that Every trade has its pros and cons, knows where his or her edge is and what the specific risks are. They have a plan for the trade before they put it on as they can’t control the market.
Think about how you trade. What type of trader are you?