On today’s episode of “Best Practices,” Tom Sosnoff and Tony Battista discuss trade entry. What key metrics should we be looking for when placing a trade?
When entering a trade, what do we look for?
1) Portfolio probability of profit / risk
3) Implied Volatility / Implied Volatility Rank
4) Notable Moves / Upcoming Binary Events / Dividends
Why is portfolio probability of profit (POP) important to a new trade? In general, all new trades we make will have a POP greater than 50%, as placing many low POP trades can create an overall portfolio that is unfavorable.
Why is Liquidity important? Liquidity allows traders to enter and exit positions quickly and with minimal slippage costs. We can determine the liquidity by looking at the open interest, trading volume and bid/ask spread of the options.
Why does implied volatility (IV) and implied volatility rank (IVR) matter? IVR tells us where an underlying’s current IV is compared to where it has been over the last year. This enables us to choose appropriate strategies based on current IV/IVR level, as we prefer to sell options in high IVR situations.
Why should we be aware of upcoming binary events? Some upcoming binary events such as earnings or scheduled company announcements can cause large gap moves in the stock, sometimes against our positions. We will avoid placing trades in a cycle that has these types of events unless the trade is specific to playing that binary event.
How do we choose a strategy? After identifying a suitable underlying, we will select a strategy based on the desired risk we are looking to take relative to our overall portfolio.
What metrics should we be aware of after selecting a strategy?
1) Probability of profit (POP)
2) Buying power reduction (BPR)
3) Loss potential / exit for undefined risk trades
4) Max return on capital (ROC)
5) Break-even points
Tom described himself as a directional trader. Tom said, "I usually makes trades that fit into my bigger picture of what I want to do. Generally speaking, I'm not going to do something that upsets the nature of my market opinion. The reason for that is when the market does what I want it to do, I want to win." Tom stated the importance of Liquidity, IV Rank, Notable Moves and Strategy. Tom said, "This would be my order of preference (to place a trade)."
Tom ended with, "If you use these tools they will all eventually become second nature to you."
Join Tom Sosnoff and Tony Battista in this segment of "Best Practices" for an excellent discussion of trade entry.