Restricting the trade universe

Options trading books for beginners typically follow a fairly well-worn path. Firstly, a call and a put option is explained. Then volatility is discected and the Black-Scholes model is discussed. Which leads perhaps to put-call parity and the greeks. Theory over, some multi-legged trades are considered. These have exotic names like “Iron Condor” and “Butterfly”. Armed with a few payoff disgrams, you are now ready to take on the world!

All this is fine but, if you are gonig to win in the ASX options market you need to focus on the key factors for success. One of these factors is “restricting the trading universe”. By this I mean ruling out what NOT to trade.

Australian options market

In comparison with the US market, the Australian market is defined by a few key factors:

1. Trading and liquidity is concentrated in a few stocks e.g. XJO (the S&P/ASX 200 Index), BHP, the banks and Telstra. In comparison in the US there are many liquid symbols spanning different industries.  In addition to stock options there are also options on funds, commodites, FX and futures.
2. When you trade, your counterpart is likely to be a market-maker. For a bit of explanation, “market-markers” are authorised by the ASX to quote buy and sell prices for options. They are obligated to quote prices for various strikes and expiries for a minium amount of time during the day. There is a higher probability of trading against a real person when trading in the US.
3. Commissions are higher in Australia than in the US.

My trading guidelines

I suggest the following guidelines (with the proviso that its OK to break them with a good reason).

1. Focus on liquid underlyings (e.g the name above). Spreads are typically tighter, which gives a fighting chance.
2. Focus on the closest expiries (e.g. the next 3)
3. Be careful with trades with three or more legs (e.g. condors and butterflies) esp if not on the XJO.

What I trade

1. I exclusively trade XJO options with a heavy focus on the next 2 expiries which tend to be the most liquid.
2. I am equally happy to be a buyer and a writer.
3. I trade several strategies including straddles, strangles and unbalanced butterflies in addition to buying / writing single options.

Happy trading

Ed