The ‘Holy Grail of Options Trading’ is an elusive prize that every options trader has sought – in vain. Newbie options traders are often lured by the magical and mystical world of trading options and the promise of immense wealth in a very short period of time. Some are fortunate (or perhaps unfortunate) to be lucky in making a few quick profitable trades when they begin trading, which lead them to believe that they have the ‘Midas’ touch. Most beginning options traders lose money quickly, and become discouraged and give up on trading options. The ones who persist and spend their time to learn the finer nuances of options trading (especially the secrets the greeks reveal about a trade) end up being successful. However, none ever forget their quest for the ultimate options trading strategy – the ‘Holy Grail of Options Trading’ that always makes money regardless of market volatility conditions and price movement.

What is the ‘Holy Grail of Options Trading’?

Let us consider the elements of what we would wish in such a ‘Holy Grail of Options Trading’.

1. It should make money whether the stock or market goes up, down or even stands still
2. It should make money whether volatility rises or falls
3. It should be resistant to the effects of emotions (FEAR and GREED) affecting profits and losses
4. It should ideally have no risk (no loss)
5. It should be simple to implement and not complicated or time-consuming to maintain

Translating the ‘Holy Grail of Options Trading’ into ‘Options Trading’ terminology

Let us consider the above requirements and translate them into options trading terminology

1. To make money if the stock or market goes up, we could buy a call or a call spread or sell a put spread (‘bull put spread’ or ‘put credit spread’) or other ‘positive delta’ trades
2. To make money if the stock or market goes down, we could buy a put or a put spread or sell a call spread (‘bear call spread’ or ‘call credit spread’) or other ‘negative delta’ trades
3. To make money if the stock or market ‘stands still’, we need the trade to be theta positive
4. To make money if volatility rises, we would need the trade to be ‘vega positive’ and the converse is true for falling volatility
5. To eliminate the effects of emotion on trading, we would need the system to be ‘automatic’
6. To have no risk, we should have a way for the profits (credit received) be equal to or greater than the losses (debits when the trade is initiated)

Is the quest for the ‘Holy Grail of Options Trading’ a lost cause?

If we consider the above requirements, we can clearly see that some are in conflict – the stock or market cannot go up and down at the same time, and volatility cannot rise and fall at the same time. By implication, no single trading strategy can be the ‘Holy Grail of Options Trading’.

However, before we give up on our search for the ultimate strategy, we should remember that many of the great inventions that we consider commonplace today were created by people to dared to think ‘outside the box’. Good examples are the airplane, the telephone, the television, etc. Similarly, to find the ‘Holy Grail of Options Trading’, we may have to think creatively.

Perhaps, we could make use of some of the nuances of OTM, ATM and ITM options to create the ‘Holy Grail of Options Trading’.

1. Delta and Gamma – Consider a call option that is OTM (out of the money); as the stock price rises and approaches the OTM call strike price, delta increases (conversely, as the stock falls, delta decreases). Interestingly, the rate of change of delta (gamma) increases as the stock approaches the strike price (ATM – at the money) – gamma is greater for OTM options with deltas between 25 and 50 than for OTM options with deltas less than 25. Similar patterns are observed for the ITM (in the money) options and for puts – deltas of options closer to ATM change faster than those of options further away from ATM.
2. Volatility – Volatility is generally highest for the nearest month than further away in time, and can change dramatically with news events.
3. Theta – Effects of time on theta decay is greatest for the ATM options and accelerates in the last 30 days, while theta decay is fairly linear for options that are further OTM and ITM.

Building the ‘Holy Grail of Options Trading’

While all the requirements for the ‘Holy Grail of Options Trading’ cannot be reconciled into a single type of (possibly complex) trade setup, we can take advantage of the above nuances to create a ‘Holy Grail of Options Trading’ system. Details of how to create such a system are beyond the scope of this article as it does require options traders to learn more about the effects of volatility and the options greeks to be successful at implementing such a system. However, for savvy options traders, here are some thoughts on the subject to consider as you develop your own ‘Holy Grail of Options Trading’.

The ‘Holy Grail of Options Trading’ system consists of a small number of trades (a minimum of 2) on highly liquid stocks or ETFs that are complementary, such that the potential profits of the trades exceed the potential losses.

Let me suggest some guidelines for such a ‘Holy Grail of Options Trading’ system.

1. Only use highly liquid stocks and ETFs with highly liquid options – One of the best ways to make money is not to lose money, and only trading stocks and ETFs with highly liquid options will decrease one of the inevitable losses that all traders face (see ‘Why Liquidity is Important’).
2. Follow the rule ‘Cut your losses short, let your winners run’ – By selecting trades where the potential profits of the trade exceed the losses, you put the odds of success in your favor (See ‘The Stock Market Game’ and test the concept with ‘The Stock Market Simulator’).
3. Put Gamma on your side – Pick trades such that when the trade is winning, gamma accelerates the profits, and when the trade is losing, gamma slows down the losses (see discussion of Delta and Gamma above).
4. Select complementary stock or ETF trades – This may be done by picking stocks or ETFs that are negatively correlated with each other, or by picking trades that have the opposite delta (positive delta and negative delta trades).
5. Pick one or more theta positive trades – Few things are certain in this world, but the passage of time is, and credit spreads are a great way to generate income via theta decay.
6. Consider ratio spreads – Properly structured ratio spreads allow the savvy option trader to profit from theta decay as well as increases or decreases in volatility.
7. Use GTC orders to close trades – Often the biggest hurdle to generating consistent profits is the options trader’s emotional reactions to the changes of price and/or volatility on the trade – one of the best ways to overcome this challenge is to ‘automate’ one’s trading by the use of GTC orders (see ‘Power of the GTC order’).
8. Always seek to minimize risk – Unfortunately, while risk can be minimized or controlled, it can never be totally eliminated. Savvy options traders look for ways to adjust trades to minimize the risk in the trade.
9. Aim for modest profits consistently – By generating as little as 2% a month, one can become phenomenally rich (See ‘Become Rich Using the Power of Compounding’).

All the Best in your quest for the ‘Holy Grail of Options Trading’,

Happy Trading!

JonLuc