Happy Friday, traders…
Jeff here.
Online trading forums are chock-full of people explaining why they’re buying certain stocks or options.
But it’s just as important to understand when you should not enter a setup.
This is especially true in this questionable market environment, where the major indexes are facing serious selling pressure for the first time in months and individual price action is looking sloppy.
When it comes to options trading, not every setup screams “buy!” In fact, certain setups are obvious “no-trades” in my book.
They’re impossible to justify based on certain conditions…
Trading around these conditions has helped me manage risk, improve my performance, and avoid brutal losses.
And in a market as wild as this one, knowing when to pull the trigger (and when to sit on the sidelines) is more important than ever.
With that in mind, let’s explore three key reasons why I might decide to pass on an options trade…
Red Flag #1: Binary Outcomes
Most importantly, I try to steer clear of binary bets.
A binary bet presents a situation where the outcome is all or nothing.
The market could swing up or down, but regardless of how much it moves in either direction, the trade outcome is binary — resulting in a total win or a complete loss.
This is like betting on red or black in roulette or flipping a coin for heads or tails.
For example, imagine you’re considering an options trade that will only pay off if a certain event happens, say, a company’s earnings beat expectations.
CAUTION: If the event doesn’t occur exactly as anticipated, you could lose your entire principal investment.
This all-or-nothing approach doesn’t sit well with me because it doesn’t allow for nuance or “degrees of correctness.”
I prefer trades where the potential outcomes are not so black and white, allowing for partial wins or losses based on the extent of the market movement — not just its near-term direction.
Red Flag #2: Expensive Underlying Stocks
Another crucial factor for me is the cost of the underlying stock.
If a stock’s price is above $500, the options premiums associated with it tend to be very high.
Higher stock prices generally lead to higher options premiums because the potential movement (in dollar terms) can be significant.
However, this translates to a higher upfront cost for the trader, and for me, that’s almost always a dealbreaker.
EXAMPLE: If buying one options contract costs $10.00 ($1,000 total cost) because the underlying stock is pricey, that’s too much risk to place on a decaying asset.
Options have an expiration date, and their value naturally decays over time if the underlying doesn’t move in your chosen direction.
That’s why I gravitate towards lower-priced stocks, where I can engage with options for a few hundred dollars instead.
And I suggest you do the same…
This approach reduces the risk of a significant loss on a single trade and might give you more confidence to pull the trigger on excellent, lower-priced setups.
Red Flag #3: High Implied Volatility
High implied volatility (IV) is the third red flag for me.
Implied volatility reflects the market’s forecast of a likely movement in a stock’s price.
Generally, the higher the IV, the higher the options premium.
High volatility suggests a greater uncertainty in the stock’s price movement, which theoretically increases the chance of an option finishing in the money.
However, when IV surpasses 100%, the cost of entering the trade often outweighs the potential return.
Such high premiums mean that the stock needs to make a very significant move in your favor to justify the initial investment.
This resembles the dilemma with expensive underlying stocks — you’re paying a lot upfront for the possibility of a mid-sized return.
The risk-reward ratio in these scenarios doesn’t match my trading philosophy. I look for opportunities where the upside justifies the cost and risk involved, without relying on extreme market movements.
You see, knowing when not to trade is just as important as knowing when to pull the trigger.
By avoiding binary bets, steering clear of options on overly expensive stocks, and being cautious around high implied volatility — you can minimize disappointing losses.
Avoid setups that fall into these categories and you’ll be a better trader for it.
Remember: Sometimes, the best trade is no trade.
Happy trading,
Jeff Zananiri
P.S. With so many “no-trades” coming across my screen, I’m sticking to proven strategies…
Like my AI-powered GAMMA System, which has already alerted trades that returned 145%, 235%, 630%, and even 900% — all in 24 hours or less*
TOMORROW, January 4 at 2:00 p.m. EST, my buddy Danny Phee is hosting a SPECIAL LIVE WORKSHOP to show you how to start weaponizing GAMMA for huge overnight gains.
Seats are limited — Don’t miss your chance to join.
*Past performance does not indicate future results
