Options Rules for the Risk-On Portfolio

Options can be a valuable way to hedge if used properly. They can also be used to goose returns by using call options and puts if you are going long or short respectively. On the other hand if used improperly they can be a wonderful way to quickly destroy your portfolio.

Here are my rules when it comes to buying options

1. Buy deep in the money (DITM) with a delta of 80 or better. All that means is that if the underlying asset moves 1 point the option should increase by about .80 cents.    
   
   1. For deep in the money high delta options time value will increase as intrinsic value decreases. This allows an investor to control risk and of course the option can only go to zero so you already know what your maximum loss will be when you buy the option. Now if the position had moved against me the option will decline in value slower than underlying asset.
      
2. Those buying out of the money (OTM) options by more than a dollar are generally buying lottery tickets.
   
   1. Most options expire worthless
      
3. Shorting or selling puts without a hedge creates huge percentage loss potential – don't do it. The risk/reward is far away from your favor.
   
   1. If you sell a put, the market has the right to make you buy those shares at the agreed upon strike price. Theoretically if the value of the underlying asset goes to 0, only the put sell amount was made. If you take the strike, and divide by zero, you get an infinite loss percentage.
      
4. Buy options with high open interest so when you make a transaction there is liquidity for that date/strike there will likely be someone ready to take the other side of the trade.
   
5. Do not buy options with market orders. It's likely you will get a price outside of what the bid/ask is showing.
   
6. Check prices for option dates even further out than what you are planning the move to take, since the price difference may be minimal and offer you more of a time window to see your view come to fruition.
   
7. If you want to take an equity position as a part of your portfolio, you can replace it with calls, but only buy the # of contracts at the strike that equals that equity position you would have taken.
   
   1. For example, If you wanted $50,000 in SPY, and the SPY strike is $50 with a price of $10, only buy 10 contracts, don't buy 50 contracts.