Trading options is like playing Lego

Trading options is like playing Lego in so many ways. You pick up small Lego pieces – those would be single options in trading – and your imagination is the only limit for what you can end up building depending on your trading objectives.

Kids discover Lego sooner or later in their childhood and then their “playing” life may never be the same. So do traders discover options and most never go back to trading the way and the instruments they had traded before.

I realized these by observing both my own kid and her friends upon discovering Lego. On the trading side many traders came to our workshops after losing tens of thousands of dollars by trading forex, futures or CFDs. They turned around their trading life by becoming profitable option traders and wished they had discovered options earlier.

The simplest options Lego pieces

The simplest option strategy available is when you buy or sell a single option, either a call or a put. Regardless if you use them as a proxy for the stock or for a pure intraday speculative trade you will benefit from the options leverage. Your capital usage efficiency greatly increases. Instead of putting down a lot of cash for buying or selling stock you risk a much lower margin by trading the single option.

The only margin required when you buy an option is the premium you pay for it. When you sell an option the initial margin requirement is usually 20% of the respective stock value at strike.

Option traders should know the rights and the obligations arising from trading single options. When buying risk is capped and potential profit is theoretically unlimited. When selling profit is capped and potential risk is theoretically unlimited. Bottom line is that trading single options is just the first step of playing the options “Lego”.

Taking it to the next level – who wants higher probabilities?

When you sell both an OTM (out-of-the-money) call and an OTM put in the same expiration you create a Short Strangle. This is a great income strategy in any timeframe provided you know how to manage the risk during the trade.

The Short Strangle strategy comes in with certain advantages. The most attractive one is the fat credit received into your account right upon getting filled. Of course the credit size depends on what strikes and expiration you chose. It can be entirely booked as realized profit if the stock finishes within the two strikes at expiration.

The strategy also has its own limitations. The one that scares most beginning option traders is the theoretically unlimited risk on both sides of the strangle. Bottom line here is that the Short Strangle is just the foundation upon which you could start building other options “castles”.

Trading options is like playing Lego – who wants higher yields?

Lego options strategy #1

Let’s say I don’t like the unlimited risk on both sides of my Short Strangle. Then I buy both a call and a put at the same strikes as my Short Strangle options but in a further out expiration. The result is called a Double Calendar. It involves a debit transaction and is has an increased capital usage efficiency compared to my initial position.

Lego options strategy #2

Let’s say I also wish to reduce the unlimited risk but this time around I play something different. I buy both a further OTM call and a furher OTM put in the same expiration. What I end up with it’s called an Iron Condor and a credit transaction. This is another beautiful income strategy with an increased capital usage efficiency, as well.

Lego options strategy #3

If on the top of my Short Strangle I buy both a call and a put at further out strikes and also in a further out expiration I then end up with a Double Diagonal. This can be both a credit or a debit transaction, depending on the protective put and call strikes and expiration. The strategy comes in with even greater versatility than the previous ones.

Why is playing the options Lego worth learning?

Kids may not go for more advanced structures the very same day they discover Lego. Learning to gradually build piece by piece into more complex is part of their practical life discoveries. The toy fosters their creativity, teaches them problem solving and being organized. It’s irresistible and they simply love it.

The same applies in options trading. Learning more advanced options strategies may seem difficult at the beginning. But if you are in for 40%+ up to 100% profit per year, these strategies should be considered. The question is: are you achieving these trading results the way you are currently trading?