Front-month options, back-month options, LEAPS – how does a trader know how much time to buy with options? John Jagerson of SlingShot Trader explains which expiration he chooses and why.
We received a question: “Why do your suggested options trades typically go out a month or two when longer-range options are available?”
Our time horizon that we’re trading, generally, is very short, so it’s pretty rare for us to be holding a position longer than two weeks. As a general rule of thumb, we want to avoid the 14 or 15 days before expiration. So, we want to buy enough time to allow us to hold the trade for a few weeks if we need to, but not buy so much time that we’re spending a lot on the option so we can get an efficient bang for our buck.
So, buying the longer-dated option we’re going to make a little less and we’re going to spend a little more to buy it when we’re right. It would allow us to hold the trades for longer, but we’re never generally planning for that so when we are, we try to accommodate that. In other words, if we think a trade is going to take, say, a week to play out, then we want an extra 15 to 20 days on top of that, so that would put us out a month.
If we think it’s going to take two or three weeks, again, we want to add on at least 15 to 20 days on top of that because we want to avoid holding a trade when there’s less than 15 or 20 days to expiration because that’s where time value erosion really starts to accelerate very, very quickly.
Having said that, there’s nothing wrong with longer-range options. So, if you want to trade something that’s got a longer expiration on it, I wouldn’t argue with you. In fact, we have a lot of traders who are professional or semi-professional that are with us at SlingShot Trader, and I get emails all of the time saying, “I like this pick, but here’s how I modified it.”
I’m always interested in how you change it, and I do get emails periodically from traders who say, “I like this pick. I think it’s got a lot more rip and run than just a couple of weeks so I bought a longer-term expiration.” I’d be very interested in hearing about it.
But, generally, that’s the timeframe that we’re looking for.
Investor Place advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.