Dynamic trading strategy, for lack of a better name, is a trading philosophy that uses call and put options in combination with underlying stocks or futures contracts to achieve limited risk, unlimited profit, and maximum flexibility in any trading situation while avoids the risk of the trader. death trap’ from being constantly ‘shocked’ out of position. Since there are only three things a stock can do (up, down, or sideways), a dynamic trading strategy is pretty straightforward.
For example, if you decide that a stock is likely to go up significantly, first, determine the amount of risk involved for 100 stocks. To do this, look for an appropriately priced, near-money strike price put option with a reasonable expiration date. Risk = action + sale – strike. (Note: risk = time value of the put option, in this situation). This combination of long action and long sell is known as a ‘synthetic’ call option.
Then add three times the ‘risk’ to the share price. If the resulting ‘target’ price seems ‘reasonable’, you have found an ‘adequately priced’ option. Three to one is a good starting risk/reward ratio.
Money management dictates the amount and size of the position. To do this, determine the maximum dollar amount you will risk on the trade. This must be a percentage of the total capital. Many merchants consider 2% to be reasonable.
Dividing the maximum amount of risk by the risk involved per 100 shares determines the number of trading units or the “size” of the position.
dynamic trading strategyWithout risking any capital, you have just answered the three questions every trader should know before placing a trade:
1. How much can I lose if I’m wrong?
2. How much can I win if I guess correctly?
3. How long will it take to find out?
Not having to place ‘stop loss’ orders, thus avoiding the fate of becoming a victim of ‘search and destroy’ missions (i.e. ‘ambushes’, the aim of which is to whip traders out of their positions ) means Get a good night’s sleep, regardless of what the market does to try to beat you (and it will).
However, because his ‘worst case scenario’ is known upon entering, he cannot deal further damage to him, no matter what. Even if the shares hit ‘zero’, your put protection is complete.
Dynamic trading strategy is flexible
When, how and under what circumstances to close one’s position is a matter of style and personal choice.
You can choose to close the position all at once or withdraw it in stages.
Strategists, for example, have been known to phase out their positions in thirds:
The first third when the profit covers the ‘risk amount’ of the entire position. Achieving this leaves the remaining position ‘risk free’. (Note: Mental or real trailing stop orders can be used from this point on.)
The second third in a predetermined target at the merchant’s choice. This is where the trader can make use of ‘contingent’ orders such as OCOs (one cancels another).
The final third is where the trader ‘attempts to hit the fences’, allowing the market to take the position with a trailing ‘stop’ order or, if the ‘tape’ indicates evidence of a ‘stop’ being placed. , simply exit the position.
Alternatively, at the trader’s discretion, the position could be ‘transformed’ into a ‘fence’ by selling call options. Note that all that is required to make the position ‘risk free’ is to obtain a call premium sufficient to cover the time value of the put options you hold.
On the other hand, if volatility is low, you might initially buy call options as a substitute for a long stock position. Once again, the maximum risk is limited, while the profit potential is unlimited.
On any decent rally, the stock could be shorted without risk. If the stock goes down, the ‘short’ stock position would be bought or ‘covered’. The trader then waits for the next rally and shorts the stock again.
The first time the profits from ‘draw’ trades exceed the cost of the call options you hold, the position thereafter becomes ‘risk free’.
If the stock continues to rise after being shorted, the trader simply “exercises” or “calls” the stock to close the position. The profit was locked in at the time the underlying stock was shorted. The combination of long call options and short stocks is known as a ‘synthetic’ put option.
All of the above can just as easily be applied in reverse in bear market scenarios by selling stocks short and buying call options (synthetic put) or simply using a put option as a substitute for shorting stocks.
A long sell position can be ‘transformed’ into a synthetic buy position simply by adding long shares.
The synthetic call can be transformed into a “bearish fence” by adding short put options to the position.
The moment a long stock is added to a profitable long put position, the position becomes ‘risk free’. The stock can be bought in a significant drop with impunity. Gains can be taken on rallies or exercised on further dips. The merchant wins, either way.
As a business philosophy, a dynamic trading strategy It’s hard to beat, don’t you think?