Factor-based strategies and trading systems are all the rage these days. We've been promoting these for many years now but it seems that more and more investors are catching on. Here are the five most important factors investors should consider when choosing a trading system.
Note: These ideas came from the book The Complete Guide to Factor-Based Investing by Berkin and Swedroe.
1. Persistent
- Whatever factor you are using has to be persistent.
- Persistency means that it holds across a lot of different time periods and across a lot of different market environments.
- The ability for an options trader to generate income using option selling strategies is very persistent.
- Capturing IV risk premium, the edge that goes to an option seller for selling premium and taking on the risk that an option buyer doesn't want to take on, is profitable over a long period of time.
2. Pervasive
- The pervasiveness of a strategy means that it holds across different sectors and asset classes.
- Oftentimes, when something works in one place, it doesn't necessarily work in another place.
- However, when trading options - whether on U.S. indices, foreign indices, commodities, volatility products, or emerging markets - it is still profitable.
- Options, as an investment vehicle, have a wide range of different asset classes from which you can move in and out of.
- Essentially, you can move your entire portfolio from one asset class to another asset class and have a reasonable level of confidence that it will still generally create a profitable outcome.
3. Robust
- A robust strategy means that it holds for various definitions of strategy criteria.
- With options trading, you can generate money in many different ways and market directions.
- You can mold and create the options strategy that you want to use - options trading does not have to be one-directional.
4. Investable
- Compared to a few years ago, trading costs have gone down significantly.
- For most options traders, the investability of options has never been easier.
- The next leap in the investing world for options trading is going to be breaking down geographic barriers - breaking down the borders between countries so that we have a truly global market for traders.
5. Intuitive
- When trading options, it has to make sense logically why there is a tradeoff between risk and reward and between the behavior of the buyer and the seller.
- Options trading is essentially a transfer of risk - very intuitive.
- The exchange of value and the transfer of risk is something that everyone does automatically — a very logic-based, intuitive reason why options trading will continue to exist moving forward in the future.
Why do I think these factors will persist with option selling? Until we can accurately predict both the future price and the path to that price, I believe the implied volatility risk premium edge will persist as markets overshoot and undershoot expectations.
Option Trader Q&A w/ Dan
Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today's question comes from Dan:
Another website said we should try to choose options with less than a 10% spread. I'd like to compare this to implied volatility and to volume; I'm sure they're all related. Which one of these is the most important to look at: spread, IV, or volume? Do you need to look at all three or just two of these?
Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.
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