Trading Options for a Living

Option Trading Topic: This is meant to throw a bit of a scare into those of you option traders out there aspiring to make a living trading options full time. Happy Halloween!

Dear Options Trading FAQ:

What percentage of option trades expire worthless? What is the number for professional traders? I ask because I hope to become a full time options trader and want to know the odds of being able to support myself doing it.

About to Quit my Job to Chase Options

Dear Options Trading FAQ:

This is sort of a personal inquiry about my hopes for options trading. I know it's risky to trade options, but I seem to really love trading. I dream about becoming a professional options trader - working at home and supporting myself just by trading and then if I’m successful, managing money for others. I am a psych doctoral student with a spouse and young child and will graduate next year.

I can find some research or company job if I want to, for about 40k$/yr or more, but I want to be my own boss if possible. I used to want to become a professor with a stable $50k or so salary, but my mind is now caught on the idea of trading options for a living.

My questions is: Can I feed myself and my family with this kind of "job"? My husband and I are dreaming of building wealth by trading, and to work at home. Right now we are doing stocks and options, and I would like go into financial futures and commodities later on. We are not very successful yet but we feel hopeful that we will start to see the sunshine. I wish for great success as an options trader.

Optimistic About the Future of Option Trading

Dear Aspiring Option Traders:

I get many letters such as these from folks hoping to become full time option traders. I am touched by the earnestness and hopefulness that is apparent. Sometimes the naiveté shown just strikes something within me that really tugs at my heart, triggering such bittersweet memories of my own initial hopes and dreams about Wall Street.

So let me say this as gently and supportively as possible: It is an extremely difficult proposition at best. As trading guru William Eng writes in his upcoming book (excerpts appeared recently on misc.invest.stocks), you are up against the smartest minds in the world. When you get to the core of it, the essence of trading is outsmarting the next guy to take his money. Professional institutional traders have the backing of tremendous resources behind them. The at-home trader with his 15 minute delayed TV tape and deep discount order clerk is quite outclassed.

Trading for personal income is VERY, VERY difficult. Even for the Wall Street pros. The best traders in the world can do their best when IT IS NOT THEIR OWN MONEY. When the money means something to you, it becomes mostly a psychological matter. (Maybe the psych major in the above letter will have an edge. I have often said to myself that if I go back for a Ph.D., it will be in the field of psychology, specializing in group behavior/ herd mentality.)

The public is usually not aware of the rigid rules set in place for the pros on Wall Street. They are designed to cut out the psychological pressures that bedevil the rest of us. For example, how many of us can really limit our losses to a reasonable level? Not many, I daresay. In theory, we can set an arbitrary stop-loss level but it is so difficult to keep.

Let’s say you open a $10,000 account with the idea of closing down the whole thing if the equity drops to $7,000. You fool around a bit and find yourself below that level one day. Do you now offset all your positions and call it a career? Do you pick up your marbles and go home? Can you face up to your losses? It isn’t easy. You’ve been telling your wife about the wins but not the losses. How do you ‘fess up now? Haven’t you been hanging your ego on this trading thing? How about leaving the money in and trading out of the situation? Yeah! Bingo! Sound like a scenario from a major Japanese bank? These feelings are only human and plague all of us.

On Wall Street, the trading rules are set as simply as possible. A system is designed that, if followed strictly, should bring in a certain amount of profit each week, each month and, each year. Pro traders might have bad days or even bad weeks, but, in the long run, they have to be profitable to keep their jobs.

The secret to letting the trading system work is in the management of losses. The specific numbers change but they go something like this. Let’s say that you are allowed to goof up and lose a maximum of 10% a month with a generous overall max loss of 30% before you get booted out the back door. It will be structured like this: Once you hit your max loss for the month (regardless of time, whether it be trading day #20 or on the first of the month), you get a stern lecture and are forced to sit out the rest of the month without trading. Oh, don’t worry, you won’t be idle - the rest of the guys will need their coffee and donuts. For the gunslingers on Wall Street, this down time is pure torture. Come the new month, you can start up again but be careful of how you trade, everyone will be watching. A couple of these forced trading stops and you are history.

The point is that there is a strict structure in place to keep the junior traders away from their worst enemy - themselves. When the head traders start monkeying around and get into creative ways of hiding the embarrassment of bad trades, you get the likes of Barings and Daiwa Securities.

To hope to support a family on your own trading may be a pipedream. Household bills come with amazing regularity. Profits on Wall Street seem to have their own schedule. Also, keep in mind that what you generate in the account is not all yours. Uncle Sam needs his share of last year’s winnings and won’t care that you blew it on a bad trade before the April 15 deadline. Somehow when your employer withholds the taxes from your payroll, it sticks around as a credit to your taxbill. Pretty neat.

The abovementioned trading hopeful mentioned a 40k or 50k job. Accounting for expenses, taxes, and such. this is equivalent of clearing 100k trading profits her first year out. Hmmm. Doesn’t sound so easy does it? The $3,000 loss carry-forward is little solace should things not work out.

Having said the above, I’ll relate an amazing trading story. One of our clients, an anesthesiologist hopelessly addicted to the thrills of option trading, ran his account from 10k to 900k in just six weeks. What makes it really incredible was that it was not from riding any easy trend, or not just a few lucky hits. He adroitly traded in and out of both calls and puts on a large number of different securities. Of course, he caused quite a sensation as the number of contracts pyramided up. Casually placing 1,000 lot orders to the floor was a thrill I’ll not soon forget. Anyway, that remains the most unusual run I’ve seen on Wall Street. Oh, by the way, he lost the entire amount even more quickly than he made it. But that is another tale!

The more common story is that of traders coming in again and again with trading stakes carefully saved up and carelessly traded. It seems that upticks and downticks in the market don’t seem like money to people. If you misplace a $20 bill in your house, you’ll spend a good amount of time walking back and forth looking for it. Yet, folks will sit and watch much larger chunks of their equity fly by with each tick and nary bat an eye.

If you are hell bent on pursuing your trading interests, at least get a solid education. Here is a partial list of must-read trading books. Technical Analysis of Stock Trends by Edwards and MaGee. Options as a Strategic Investment by Larry McMillan Market Wizards and New Market Wizards by Schwager. And as an eye opener, try the Gene Marcial (he writes the Inside Wall St column in Business Week) book, Secrets of the Street. An excellent trader's magazine is Technical Analysis of Stocks and Commodities. And of course a good set of chart books are essential.

It is not easy, as the statistics show. The first reader mentioned asked for the percentage of options that lose money. I happened to see a post on this very matter. I quote from a recent post from www.interaccess.com : "...OCC economists estimate that 30%-33% of stock and index options expire worthless, and perhaps as much as another 20%-33% are offset at a loss." Let's add that up. That seems to be up to 66% losers. The edge seems to then go to the option seller, not the buyer.

Indeed, premium selling strategies are preferred by pro traders. The favorable margin requirements allow them to steadily collect small gains over and over again. Long side shooting is left to the public speculators who find the naked requirements too exclusive. With the cards stacked this way, it is difficult to try to trade for a living.

Many readers may write to say that it can be done. I will admit that for some it may be a reasonable proposition. Some may have the discipline, the gumption and the capital to pursue it successfully. If you have plenty of risk capital, personal discipline to stick to a winning system, a rock solid grasp of money management and the personal freedom and time to devote to it, then you may want to try it out on a small scale. DO NOT THINK ABOUT IT if you have dependents riding on your trading success. This is not responsible action. I have personally been witness to family breakup, marital strife and even suicide on Wall Street. The market is a head game and I must say that not many of us should take peeks into those heads of ours. We may not like what we see.
Happy Halloween.

Parting options trading advice: Try not to invest too much of your psyche into your trades. The sad part about a losing trade is the deflating effect on one’s spirit. Letting the market trounce your wallet is one thing, letting it ravage your soul is another.

From one trading fool to another: Good Luck. Be Strong.

Good luck and trade well! Remember, an educated options trader is the best options trader. Browse these books books on trading options.

Tags: Options Trading, Options Broker, Options Order, Stock Market Trading, Professional Trader

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