Fred Ruffy has spent the last decade trading options and educating traders regarding the benefits of options.
“My philosophy on trading options is to create strategies that have predetermined risk and reward levels. I want to have a good range of profitability,” Ruffy says.
Having your total risk set when entering a position is more important than ever, given the volatility of the last year, which is leading people to options. “More and more people are trading options,” he says.
“I like to set aside a predetermined amount where you know your risk. You have a profit range where you are willing to risk X amount to make Y amount,” Ruffy says.
For this he trades covered calls, bear and bull call spread and butterflies.
Ruffy is senior options strategist at WhatsTrading.com, a Web site that provides information on equity options, index options and options on exchange traded funds (ETFs). “We monitor bullish and bearish activity in the options market and note the more interesting trades,” Ruffy says.
The Web site is open to everyone. “We write a morning update and provide updates throughout the day,” Ruffy says. There is also a premium section with more detailed information including more options charts and premium stories for a fee.
While Ruffy likes trades with a favorable risk/reward profile, he doesn’t have a set target like 3 to 1. In some cases the ultimate risk could be greater than the ultimate profit if those cases have compelling odds in his favor. “For most of the options strategies, there has to be a compelling risk/reward profile that makes more than I risk but there are exceptions to those rules.”
One example of a good risk/reward scenario is a current butterfly he has on in Legg Mason. “I noticed that there had been large institutional traders accumulating call options [in Legg Mason]. There was a reason to expect a bounce,” he says.
Instead of buying calls, Ruffy executed a butterfly. He sold two April 15 calls and bought one April 12.5 call and one 17.5 call. The position cost 55¢ ($55 for one butterfly) plus commissions.
Legg Mason is a brokerage firm with solid fundamentals that has been hit hard along with most other brokers recently and was possibly undervalued. The position is currently profitable and has a profit range of $13.05 to $16.95. If he does not exit beforehand, the positions will be profitable if the underlying stock remains in that range at expiration. His total risk is $55 if it settles below $12.50 or above $17.50. He can earn a max profit of approximately $195 per butterfly if it settles at $15.
He also has been trading more index and ETF options using simple vertical spreads. “If it looks like a sector is moving I like to do bull and bear call spreads with good risk/reward ratios.”
He notes that more and more people are trading options because you can create positions with a predetermined risk/reward.
This is obviously important over the last year when volatility has exploded. Ruffy says he has traded less frequently and has a longer time frame. Because the overall decline in equity markets has affected nearly everyone, there may be some bargains. “It is more looking at specific situations and stories, rather than broader market move. I think there are stocks with good individual stories that were decimated,” Ruffy explains.
As he looks for these stories, he will only enter positions where he knows precisely how much he can lose and where the rewards outweigh the risks.
