RiverTree Guidelines for Options Trading

Options trading strategies create a great variety of opportunities for profit generation and risk management.  However, the complexities of equity options require a systematic methodology.  These guidelines are intended as a method for equity options trading, managing a modest portfolio, and beating market returns over time.

Benjamin Graham, who was Warren Buffett's finance professor at Columbia, said “Successful investing is about managing risk, not avoiding it.”  This is especially true for options where trades are affected by the passage of time and price volatility.

RiverTree's guidelines aren't intended as strict rules but as trading and portfolio practices that can be profitable and may be adapted to different circumstances.  In the end, each of our approaches to trading will differ depending on our knowledge, experience, resources, and risk tolerance.  Devise a flexible plan that you can follow using best practices and objective measures.

At this time RiverTree is concentrating on selling puts and calls to collect options premiums.  The following guidelines are intended to enhance trading and lead to better performance in various market conditions.  

A Strategy Overview

RiverTree concentrates on selling cash-secured puts and covered calls (buy writes) to collect premium.  These are typically considered moderately safe and relatively neutral to somewhat directional strategies.  Each of these strategies can generate multiple sources of income and has a few additional features.  In the case of cash-secured puts, secure funds can be kept in an interest-bearing account.  In addition, the lower strike allows the underlying equity to be acquired at a lower cost if assigned.  Covered calls also create several opportunities.  First, OTM (out-of-the-money) calls are sold for a premium, they may also be assigned at a higher strike price for capital appreciation.  Finally, if the underlying equity pays a dividend it may be collected during the term of the covered call options contract.

The length of an options contract and the final strike price are critical components of an options contract.  The amount of time to contract expiration and the strike price are both key to determining profit potential and levels of risk.  For those reasons, Rivertree guidelines concentrate on ways to select and manage expiration dates and strike prices.

General Trading Guidelines:

RiverTree focuses on trading options with "value stocks” or equities that are profitable according to independent rating sources such as MorningStar or Google Finance.  Preferably profitable for at least three consecutive years.

Avoid high-risk underlying assets such as leveraged ETFs, equities pushed to high evaluation or multiples, and equities that lack reliable accounting and fundamental information.

  1. Identify equities with a strong profit history and value or growth ratings. Use a screen that shows opportunities that are compatible with your overall strategy.
    1. consistent earnings.
    2. consistent dividends.
    3. moderate volatility.
    4. liquidity.
  2. Look for equities with higher levels of market interest, typically this means greater market capitalization, higher trading volume and smaller bid/ask spreads. Smaller Bid/Ask spreads will be easier to fill and close later if necessary.
  3. Select underlying equities that are not overbought or overvalued and have moderate implied volatility rankings, IVR.
  4. Focus on collecting premiums by “selling to open” cash-secured puts or covered calls.
  5. Place small and routine trades, limiting risk and maintaining a regular profit.
  6. Monitor portfolio composition and performance, maintaining diversification and limiting risk. 
  7. Watch for economic and market events that may affect the trends and price action.

Trade Selection

Select trade candidates with prices that allow for a portfolio made up of several positions and expiration dates.  Consider the merits of higher premium payments versus a greater likelihood of being assigned, ITM.

  1. Price
    1. Limit trade size to approximately 5% of the overall portfolio value.  
    2. Place small and routine trades collecting premiums equal to 1 to 2% of the trade size for each trade.
  2. Volatility
    1. Trade moderate volatility.
      1. IVR typically between 20 and 30. 
    2. Review the Delta values and the likelihood of expiration ITM when considering strike prices.
      1. Call Delta  + .20  to  + .30
      2. Put Delta   - .20  to   - .30
  3. Time - Days to Expiration or DTE
    1. Compare premiums for expiration dates between approximately 30 to 60 days.
    2. Moderate time decay or Theta values.
    3. For calls consider premium as well as capital appreciation and potential dividends.

Putting on the Trade

Select equities that are consistent with your plan including. 

  1. Equities that are uncorrelated to existing positions.
  2. Consistent with position size limits.
  3. Review Delta values at different strikes and look for a premium amount of 1 to 2% of trade and a probability for closing ITM of approximately 20%.
  4. For covered calls, select a strike price above the share cost.

Portfolio Management

Each trade becomes part of a larger store of value that is affected by time and price action.  Active monitoring and a few routine practices are helpful to recognize and respond to change.

  1. Place trades and make portfolio adjustments that are small and routine.  This helps keep pace with change and limits the potential of loss from any one trade.
  2. Consider closing positions before expiration.  Close a position when it reaches 80% of the maximum return.  This helps maintain buying power and reduce the chances of being assigned.  Also, consider closing or rolling out positions if the market and corporate events, including earning announcements, affect volatility. 
  3. Develop a strategy that takes advantage of corporate exdates, earnings announcements or the assignment of a put at a lower cost.
  4. Positions in a portfolio should have a low correlation with each other.  In other words, positions should be unrelated mathematically or logically.  This will help limit losses in a market downturn. 
  5. A portfolio that is Delta neutral helps provide a hedge against price change.  To Delta hedge the portfolio, sum of the individual position Delta values.  This total should be close to zero or slightly positive.  The overall portfolio Delta can be adjusted by adding individual positions with positive or negative Deltas.