Why Option Traders Should Sit On The Sidelines For 90% Of The Game

As kids we never wanted to be left out of the game. We enjoyed getting in there and playing hard.

But as investors we should relish in the ability to quietly sit on the sidelines and do more watching than playing.

Really it was put best by the famous Jesse Livermore who said "It was never my trading that made me money in the market, but rather was always my sitting tight."

Have those words ever been more true than they are today? With the parabolic rise in small speculator trading (both stocks and options) over the past 10 years we have found a crowd that truly enjoys the thrill of the game rather than the outcome.

I Enjoy The Views From The Bench

Trading more has recently become synonymous with the so called "smarter" trader. I disagree.

Even with the recent horrible month for equities you can see why smarter money might have actually been on the sidelines watching and drinking beer while everyone else is trying to cover their positions.

In my own personal trading I have often found that I'm best when nimble and patient. Waiting is often more likely to be a better trade at times than LONG or SHORT. When the right set-up presents itself, attack aggressively and mange risk.

Our Own Case Study

To really drive home the point I'll start right here with our own Premium Membership. To start out the first quarter of this year we were trading very light. 1 to 3 positions per month at most - hardly active.

Stocks continued to inch higher and volatility was in the teens, so trading they way we do didn't make any sense. Sure you missed a huge run up in stocks but that wasn't our game plan.

When the market started to enter the current correction in early May I began to more aggressively invest. Volatility was on the rise and the trades I wanted to make were now available. Even if we continue to see selling, this June will be a great month for our members.

The point is that I wasn't going to force trades into the market just for the sake of trading. Why should we trade just to say we have a position? Isn't it better to wait for the right position than to hope for the wrong one to turn around? I sure as hell think so.

My 90/10 Trading Rule

Though I haven't spend money on doing a major study of options traders around the world, I would strongly assume that more profitable traders spent 90% of their time on the sidelines in mostly cash. The other 10% of the time would be when they saw 2-5 opportunities each year to put a lot of money to work at favorable risk/reward ratios.

I would also strongly assume that 10% of the traders out there make 90% of the money. You've probably commonly heard of the 80/20 but I believe it's even more lopsided in the financial markets would you agree?

Cast Your Vote Via Comments

Lets hear what you have to say. Do you think you make/save more money sitting on the sidelines or do you think actively trading each week/month is more profitable long-term? Cast you vote now in the comments section!

  • Bill Place

    Kirk, spot on. This market is tough, way to many variables, Greece, spain, jobs, what have you. Example, I was in a spread short leg SPX 1285 going into Friday morning it had to drop 25 points to go below 1285, guess what, well you know. This trade would work 99 out of 100 tries. So, again I have dropped the service that provided me the trade. Am I blaming it on the service, NO, but I am tired of being up 10000, down 5000. So bottom line Kirk is the man, yes he to will have a lose also just hope I don't lose 1500 on one trade. But while the subject is trading less, I would love to have more plays from Kirk, because I know his will make at least 95 percent of times, and would be willing to pay more for more trades.

    • Kirk

      Thanks for the vote of confidence Bill as always!

  • Greg Vermeychuk

    I would in a slightly different way. A winning options trade must pass several hurdles before you ever put it on. Looking at the underlying, are you bullish, bearish, or neutral? What is your assessment of the current volatility and your outlook for future volatility? That is a tricky question in some cases. Then, what is your strategy to exploit the conditions? Finally, what specific trade will do it for you with an a high probability of a win and an acceptable risk to reward ratio? You need to spend the time to screen lots of situations, then check the theta, gamma, and vega of the positions you are thinking of. Then, when one looks good, you need to come up with a "plan B" to adjust the trade if it doesn't play out the way you anticipate. Finally, you put on the trade and follow it as it develops. All told, this is work. Trading is a business which is not easy to learn. That's why there are so many losers. If you are willing to go the distance and put in the work up front, you will do very well. Not many do, but the effort is well worth it.

    • Kirk

      Well put Greg - it truly is a process rather than an emotional thrill. Great list of questions here too that might help others who maybe don't have a trading plan set up. These will get you started for sure! Thanks for the comment!

  • JETWAKE GLOBAL

    Trading the markets will always be a ton of noise and rumors and bad information. It just happens much quicker in 2012 than it did in 1980...still,I think it is better to trade great companies. You only need four great ones to make a fortune. Remember you can be long and short at the same time, so why miss out on 90% of the game sitting on the bench? Timing is everything.

  • Theo

    For the most part, I would agree with the tenets of your article - esp. for newbie traders & traders with limited experience trading volatile markets. However, for a very saavy trader who has a strong command of spread trading, the greeks, TA, & volatility, that trader would relish any market condition, because he has enough tools in his option toolbox to make money 24/7. One strategy out of a few I employ that makes money for me on a consistent basis is the Broken Wing Butterfy (BWB - 1/3/2 or 1/4/3).

    With a Call BWB, you can put the trade on for a credit. If the stock remains flat, tanks, if there is a 'flash' crash - the trade expires OTM & u keep the full credit (up to10%+ ROI). There is NO DOWNSIDE RISK. If the stock goes your way & climbs up into the butterfly net, one can make SERIOUS profit$s.

    The only 'real' risk - the stock keeps climbing - go through your 'profit' zone (the bfly tent) & lands on opposite side of the tent. That is a low prob event because a adroit trader will take his profits b4 that happens. I can't imagine a market scenerio where this tactic would NOT be profitable (if skillfully employed on a highly liquid stock).

    • Bill Place

      @Theo, would love to know more about those theo

      • Theo

        @Bill Place, Quick example: Last thurs I put on the following June 2 wkly trade ; GOOG: 595 - 600 - 605 call BWB @ $1.30 credit / $3.70 margin. GOOG was @ 582. Today, i closed out the trade for an add'l .10 credit.

        Total credit received. $1.30 + .10 = $1.40 / 3.70 margin = 37.8% ROI. As long as GOOG remained below my 600 short strike - i would keep 1.30credit +. If GOOG went UP inside my tent- (between 595-605), the profits would have been larger. I would take my profits & run b4 I let GOOG go past 605 (my danger zone where max losses can occur).

        I did another trade today: MA 410 Call BWB @ $1.49 credit. I could have closed the trade for .80 credit (.69 profit), but I'm greedy (ha) & my forecast is MA will remain BELOW 410 by fri expiration.

      • Kirk

        Great trade Theo. Now there's a guy who at least acknowledges his greed ;)

      • Bill Place

        @Theo, I think on the first two legs you are buying to open and on the third leg you are selling to open? Thanks

      • Theo

        @Theo, @ Bill Place. With a butterfly trade - you are long Legs 1 & 3. You are short on the 'middle' strike (leg 2).

      • Omad

        @Theo, Theo, would be interested to hear how your MA trade turned out with MA at 418. Thanks

      • Theo

        @Bill Place, With a butterfly, you are long on the 1st & 3rd leg. You are 'short' on the middle strike (leg 2). For max profits, the stock has to land close to your short' (middle) strike. This would become more clear to you on a risk graph.

  • http://investingepimoni.com Francis Pierce

    I completely agree with this and practice it as much as possible. I have also found that this has been a fact for some time.

    For example the prosperous come from the latin words pro(for) spero(to hope). So to be prosperous in life, we must be willing to sit on the sidelines when the universe deems it necessary.

    I hope for the the best in trading career, keep trading presistently.
    Francis

  • http://www.steadyoptions.com Kim

    Kirk, this is a very good advice. But I think it also depends on the strategies that you implement. Some strategies will benefit from sharp moves, and since you cannot predict when those moves will happen, you might want to trade more not to miss them.

    • Kirk

      That's true if you day trade or swing trade options.

      • Bill Place

        Having sometime to dwell on this, yes, sidelines are good. Nothing wrong, in my opinion, being in all cash and wait for pullbacks. Doing that right now, and will continue to do so as I think this market could come tumbling down

      • Omad

        @Bill Place,

        Bill, if you have the assumption that the market could come tumbling down why not trade that assumption, isn't that what traders do?

        The only way to get good at something is to do it a lot, practice practice practice, why would trading be any different? This question is not directed at you specifically Bill but to everyone.

        Cheers.

  • Bill Place

    No, didn't take it personal at all. Understand your point well. I am not much on shorting even though I think it is going down. Just would rather wait on the stocks I like and get in on dips.