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The Art of Options Trading: Finding Profit in Market Movement
In a world where financial literacy is increasingly vital yet often overlooked, Michael Sincere's "Make Money Trading Options" stands as a refreshing departure from typical investment guides. The book has garnered a devoted following among both novice and experienced traders, with many Wall Street professionals quietly recommending it to their clients as a practical introduction to options trading. Unlike many trading books that promise overnight wealth, Sincere's approach emphasizes risk management and practical strategies developed through years of real market experience. What makes this work particularly valuable is how it transforms complex options concepts into accessible, actionable advice without sacrificing depth or accuracy.
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The Trader's Mindset: Managing Risk Before Reward
The journey into options trading begins not with strategies for making money, but with understanding how to avoid losing it. This counterintuitive approach sets the foundation for sustainable trading success.
Most new traders rush into learning complex strategies while ignoring the fundamentals of risk management. Yet without proper risk controls, even the most sophisticated trading approach will eventually fail. As Sincere emphasizes, "No matter how good your strategy, without successful risk management, retaining profits becomes difficult."
The book illustrates this principle through a compelling narrative about Sam, a retired teacher who plunges into options trading with minimal preparation. Within a week, Sam transforms from confident beginner to devastated trader, losing nearly $40,000 of his retirement savings. His mistakes are painfully familiar: trading with too much money, making impulsive decisions based on emotion rather than analysis, chasing losses, and ignoring risk management principles.
Sam's catastrophic week serves as a cautionary tale highlighting common pitfalls: placing market orders instead of limit orders, trading without a plan, following hot tips from neighbors, overtrading, ignoring technical signals, and perhaps most dangerously, using retirement funds for speculative trading.
The story resonates because these aren't theoretical mistakes but real-world errors that countless traders make daily. Warren Buffett's famous investing rules come to mind: "Rule #1: Never lose money. Rule #2: Never forget rule #1." Sincere builds on this wisdom by emphasizing that successful options trading isn't about avoiding all losses-that's impossible-but keeping them reasonable while earning more than you lose.
The most practical risk management advice emerges clearly: trade small position sizes initially. As your skills improve, you can gradually increase position size, but never risk more than you can afford to lose on a single trade. This seemingly simple principle is what separates sustainable traders from those who flame out quickly.
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The Test Trading Strategy: Finding Winners Before Risking Money
Perhaps the most innovative contribution of Sincere's approach is the Test Trading Strategy-a methodical system for identifying profitable opportunities before committing real capital.
Most traders enter positions based on hunches, news, or technical indicators without testing their ideas. Sincere flips this approach by using paper trading (simulated trading) not just as a learning tool but as an active part of the trading process. As he explains, "I've discovered they can help identify winning stocks or indexes almost daily."
The strategy begins with creating a carefully curated Watch List of 80-90 quality stocks priced above $50 per share. These should be liquid, widely-held companies frequently mentioned in financial media-familiar names like Apple, Amazon, Microsoft, and Google. Before market open, traders scan this list for stocks showing upward movement of at least 1 point or 1 percent in pre-market trading.
For each qualifying stock, traders place paper money orders to buy 100 shares. When the market opens, they monitor which positions gain strength throughout the morning. Stocks showing consistent upward momentum and paper profits of $200-$300 become candidates for real trading. The process continues with buying five in-the-money call options on the strongest performers as a "probe," followed by five at-the-money calls if momentum continues.
This methodical approach serves multiple purposes: it identifies stocks with genuine momentum rather than temporary spikes, creates a systematic framework for decision-making, and removes much of the emotional component from trading. As Sincere notes, "The true winners will distinguish themselves by continuing to rise while others falter."
What makes this strategy particularly powerful is how it transforms paper trading from a mere practice tool into an active screening mechanism that runs parallel to real trading. It's like having a laboratory where you can test stocks before risking actual money-a concept that seems obvious in retrospect but represents a paradigm shift in how most traders approach the market.
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Market Behavior Analysis: Understanding the Trading Environment
Beyond individual stock selection, successful options trading requires understanding the broader market environment. Sincere introduces a unique approach called Stock Market Behavior Analysis-a framework for quickly assessing market conditions using descriptive pattern names that capture the essence of price movement.
Unlike technical analysis, which aims to provide specific buy and sell signals, this approach offers a broader perspective on market conditions. "It's designed to enhance whatever method you're already using, not replace it," Sincere explains. The approach helps traders evaluate whether conditions are favorable for trading or potentially dangerous-similar to pilots checking weather conditions before takeoff.
The framework identifies specific behavior patterns that repeat daily, each with an easy-to-remember name:
The Bullish Steamroller represents a powerful uptrend that begins slowly in the morning and builds strength throughout the day, becoming nearly unstoppable by afternoon. This pattern offers some of the most profitable opportunities for call buyers.
The Bearish Steamroller forms an unstoppable downtrend that typically continues all day, though it requires more patience and caution than its bullish counterpart.
Rocky Road appears when bulls and bears wage a tug-of-war with no clear winner, creating multiple reversals from highs to lows. This chaotic pattern indicates market confusion and is best avoided by most traders.
Spike Up and Spike Down patterns create vertical lines on charts when markets move dramatically at the open. These extreme openings often trap inexperienced traders who chase the movement, while experienced traders may bet on reversals.
The Sideways Sucker makes small zigzagging moves in a tight range, making profitable trading nearly impossible. It's called "Sucker" because trading during this pattern is usually a losing proposition.
Strong Rally and Strong Sell-off patterns show clear directional movement with potential to transform into Steamrollers. These patterns offer good trading opportunities when entered early.
Slow Rally and Slow Sell-off begin quietly and often go unnoticed but can develop into powerful trends. These unassuming patterns shouldn't be overlooked.
Flat, Weak, or Indecisive patterns appear to go nowhere and signal market indecision. It's usually best to avoid trading when these signals appear.
Intraday Reversals occur when the current trend changes direction, signaling a potential shift that may carry into the next trading day.
This framework provides traders with a vocabulary for market conditions and helps them align their strategies with the current environment. Most importantly, it helps identify when not to trade-perhaps the most valuable skill for preserving capital.
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Trading SPY and QQQ: Riding Market Trends
While individual stocks offer numerous trading opportunities, Sincere devotes significant attention to trading ETFs like SPY (S&P 500) and QQQ (Nasdaq-100), which provide exposure to broad market movements.
These ETFs make excellent trading vehicles because they're liquid, non-leveraged, actively traded, and have tight bid-ask spreads. For beginners especially, they offer a more manageable entry point into options trading than individual stocks, which can be more volatile and unpredictable.
The Test Trading Strategy works particularly well with these ETFs. After market open, traders place paper money orders for five at-the-money calls with one-to-two-month expiration dates. If the market shows strength and the paper positions gain value, traders can consider real positions with fewer contracts based on their comfort level.
Sincere offers practical guidance for trading these ETFs successfully:
Profitable positions should show gains within minutes. If they don't, something may be wrong with your analysis.
Never add to losing positions, but consider adding to winners early in strong uptrends.
Watch positions closely as markets can reverse suddenly, and take profits when gains seem surprisingly large.
During bull markets, calls can be held overnight, but remember that options lose value over time due to theta decay.
Selling too early won't damage your portfolio, but selling too late will.
When buying puts, trade smaller size and be even more vigilant. Markets fall faster than they rise, providing substantial gains for put buyers with perfect timing, but even during bear markets, one-day rallies can destroy put positions.
For successful put buying, wait for a strong downtrend and watch market openings carefully. When a falling market turns into a plunge, SPY and QQQ puts can deliver substantial returns.
This section reinforces a central theme throughout the book: successful options trading isn't about predicting market direction with perfect accuracy, but about recognizing and following trends once they've established themselves.
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Advanced Strategies: Beyond the Basics
After establishing fundamental approaches, Sincere introduces more advanced strategies for experienced traders, including the Long Shot, Countertrend Strategies, Basic Hedge Strategies, and the Simple One-Stock Strategy.
The Long Shot Strategy resembles gambling more than trading, involving buying deep out-of-the-money options with 2-3 month expiration dates. While most of these trades will expire worthless, occasional big payoffs can make the approach profitable if used sparingly and with strict risk management.
Countertrend strategies involve going against prevailing market direction-a high-risk approach that can be profitable with impeccable timing. These strategies shine particularly when bull markets slow and turn bearish, causing rallies to reverse quickly. The two primary countertrend approaches focus on Spike Up and Spike Down patterns, betting on reversals after extreme price movements.
The High-Volatility Straddle strategy involves buying both calls and puts before major news events or earnings reports when you believe a stock will make a big move but aren't sure which direction. This creates the possibility of profiting regardless of direction if volatility increases further.
Perhaps most intriguing is the Simple One-Stock Strategy, which focuses on buying options in a single high-potential company showing strong uptrend momentum. By concentrating on just one promising stock and applying disciplined trading principles, traders can achieve substantial profits without complex techniques.
Sincere illustrates this with a tale of two traders: a professional using sophisticated countertrend strategies who barely broke even over four years, and an amateur who focused solely on Amazon calls during its rise from $370 to $3,500, growing wealthy through disciplined, focused trading.
This comparison highlights an important truth often overlooked in trading literature: simplicity frequently outperforms complexity when combined with discipline and proper stock selection.
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The Technical Foundation: Understanding Options Mechanics
While much of the book focuses on practical trading strategies, Sincere provides a comprehensive options minicourse covering essential terminology and concepts, making complex ideas accessible to beginners while offering valuable refreshers for experienced traders.
Options are contracts giving the right, but not obligation, to buy or sell something specific like stock at a predetermined price within a specific timeframe. Each contract represents 100 shares, making them a leveraged instrument where small investments control larger positions. For example, controlling 100 shares of a $50 stock might cost $5,000 directly but only $300-500 through options. This leverage creates both opportunity and risk, as gains and losses are magnified.
Calls are bullish positions that increase in value when the underlying stock rises, while puts are bearish positions that gain value when stocks fall. For instance, if you believe Amazon stock will rise, you might buy call options rather than purchasing shares directly. The fundamental secret to options trading is that when an underlying stock moves in price, its options usually follow in the same direction, often with amplified percentage moves.
The strike price is the fixed price at which you can buy or sell the underlying stock, while premium is the price paid for an option. For example, a $50 strike call option might cost $2 (or $200 per contract). Unlike stocks, which can be held indefinitely, options always expire after a certain date and time, making timing crucial. Weekly options expire every Friday, while monthly options typically expire the third Friday of each month.
Options can be at-the-money (strike price equals stock price), out-of-the-money (strike price above stock price for calls), or in-the-money (strike price below stock price for calls). Each category carries different risk/reward profiles and responds differently to market movements.
Two complex but crucial concepts affect option pricing: implied volatility (IV) and time value. Implied volatility significantly influences option premiums-when IV increases, option prices increase regardless of stock movement. For example, before earnings announcements, IV often rises as traders anticipate potential big moves. Time value represents the portion of an option's value derived from time remaining until expiration, which constantly decreases until reaching zero at expiration. This decay accelerates in the final weeks before expiration, particularly in the last 30 days.
Understanding these mechanics helps traders avoid common pitfalls like overpaying for options with inflated implied volatility or holding options too long as time decay accelerates. Successful traders often avoid buying options when IV is historically high and prefer selling them instead. They also typically close positions before rapid time decay erodes their value, particularly with out-of-the-money options in the final weeks before expiration.
The interplay between these elements creates a dynamic market where success requires not just directional accuracy but also proper position sizing, timing, and strategic selection of strikes and expiration dates. Many beginners focus solely on direction while overlooking these crucial mechanical aspects, often leading to costly lessons.
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Technical Tools for Success: Moving Averages and RSI
While Sincere's approach doesn't rely heavily on technical indicators, he highlights two particularly useful tools: moving averages (MA) and relative strength indicator (RSI). These fundamental indicators provide valuable insights while maintaining simplicity in trading decisions.
Moving averages provide visual signals that help traders decide whether to buy or sell and identify when trends begin or end. The most commonly used periods are the 20-day, 50-day, and 200-day moving averages. Before buying stocks or ETFs, comparing price to moving averages quickly determines if the trend is favorable. When prices trade above these moving averages, particularly with the shorter-term MAs above longer-term ones, it signals bullish momentum. The 200-day moving average is particularly powerful-when major indexes are above this level, it signals long-term bullishness; below indicates bearishness. Traders often watch for "golden crosses" (50-day MA crossing above 200-day) and "death crosses" (50-day crossing below 200-day) as significant trend change signals.
The Relative Strength Index (RSI), developed by J. Welles Wilder, helps determine whether a market or stock is overbought or oversold. This momentum oscillator measures the speed and magnitude of recent price changes. Readings above 70 indicate overbought conditions, while readings below 30 signal oversold conditions. However, securities can remain overbought or oversold for extended periods, so RSI should be viewed as an early warning system rather than a precise timing tool. During strong trends, RSI can remain in overbought territory (above 70) for weeks while prices continue climbing. Traders often look for RSI divergence - when price makes new highs but RSI doesn't - as a potential reversal signal.
These indicators complement the Test Trading Strategy and Market Behavior Analysis, providing additional confirmation before entering positions. For example, a trader might identify a stock showing strong fundamental growth, then wait for price to move above its 50-day moving average with RSI below 70 before buying. The emphasis remains on simplicity-mastering just one or two indicators can lead to more successful trading than trying to incorporate dozens of complex tools. Sincere recommends practicing with paper trading to understand how these indicators behave across different market conditions and security types.
Advanced traders might combine these indicators with volume analysis or price patterns, but beginners should focus on mastering the basics of MA and RSI interpretation first. The goal is to use these tools to confirm trading decisions, not to rely on them exclusively for entry and exit points.
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Lessons from a Master Speculator: Jesse Livermore's Trading Wisdom
The book concludes with a compelling historical analysis of Jesse Livermore, one of Wall Street's most legendary figures who made an astounding $100 million shorting the 1929 crash but ultimately succumbed to bankruptcy and took his own life in 1940. His dramatic rise and fall offers crucial lessons for modern traders about both successful strategies and fatal pitfalls.
Livermore's trading methodology centered on three fundamental tactics-the "three P's": Pyramiding (systematically adding to winning positions as they proved profitable), Probing (testing market reactions with small initial positions before larger commitments), and Plunging (deploying maximum capital when conditions appeared optimal). While pyramiding remains a cornerstone of trend-following systems and probing represents sound risk management, his aggressive plunging approach often led to catastrophic losses that modern position-sizing methods specifically aim to prevent.
His most profound insight was understanding the psychology of major market moves. Livermore emphasized "the big swing"-identifying and riding major market trends rather than getting distracted by short-term price noise. He discovered that his largest profits came not from clever entry timing but from maintaining winning positions with patience and conviction. "It was never my thinking that made the big money for me. It always was my sitting," became his famous maxim, highlighting how emotional discipline trumps technical analysis.
Livermore developed sophisticated methods for identifying market turning points, particularly tops. He noticed that bull markets typically ended when former leading stocks stopped making new highs and showed weakness in recovery attempts. He also recognized specific patterns in market breadth, volume, and sector rotation that often preceded major reversals. His detailed observations of crowd psychology and market cycles remain remarkably relevant for modern technical analysis.
His trading principles, documented in the classic "Reminiscences of a Stock Operator," continue to influence contemporary traders through insights like: "The market is never wrong - opinions often are" and "Don't take action with a trade until the market confirms your opinion." He emphasized the futility of trying to buy exact bottoms or sell exact tops, instead focusing on catching the "middle 60%" of major moves.
The tragic conclusion to Livermore's career - cycling between enormous wealth and bankruptcy multiple times before his suicide - serves as a stark warning about the dangers of crossing the line between disciplined trading and compulsive gambling. His inability to consistently follow his own rules, particularly regarding risk management, ultimately proved his undoing. This reinforces the book's central message that long-term trading success depends more on controlling risk and maintaining emotional discipline than on any particular trading strategy.
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The Path to Sustainable Trading Success
"Make Money Trading Options" offers more than just trading strategies-it provides a comprehensive framework for approaching the market with discipline, patience, and proper risk management. The book emphasizes that sustainable success comes from building a strong foundation of trading principles rather than chasing quick profits.
The book's central message is that successful options trading isn't about finding get-rich-quick schemes or developing increasingly complex strategies. Instead, it's about managing risk, identifying genuine opportunities through systematic testing, understanding market conditions, and maintaining emotional discipline. Sincere demonstrates this through numerous real-world examples, showing how even seemingly promising trades can fail without proper risk controls and emotional management. He particularly emphasizes the importance of position sizing, suggesting never risking more than 1-2% of trading capital on any single trade.
The Test Trading Strategy represents a particularly valuable innovation, transforming paper trading from a mere practice tool into an active screening mechanism that runs parallel to real trading. This approach helps traders identify stocks with genuine momentum rather than temporary spikes and removes much of the emotional component from trading decisions. The strategy involves maintaining two separate trading journals: one for paper trades and one for real money trades. By comparing results between the two, traders can identify patterns in their decision-making and adjust their strategies accordingly. Sincere recommends running this parallel system for at least three months before making significant strategy changes.
Market conditions play a crucial role in trading success, and Sincere emphasizes that not every day presents viable trading opportunities. The discipline to stay out of the market when conditions aren't favorable may be the most valuable skill a trader can develop. He provides specific indicators and market conditions to watch for, including VIX levels, market breadth, and sector rotation patterns. As Jesse Livermore wisely noted, "There is a time to go long, a time to go short, and a time to go fishing." This patience becomes particularly important during volatile market periods or when major economic events are pending.
The book outlines a systematic approach to market analysis, including:
• Daily market condition assessment using technical and fundamental indicators
• Regular review of trading results and strategy effectiveness
• Development of specific entry and exit criteria for different market conditions
• Creation of a detailed trading plan with clear risk parameters
For those willing to put in the work, develop discipline, and approach the market with realistic expectations, options trading offers significant potential for profit. But as Sincere repeatedly emphasizes, the journey begins not with strategies for making money, but with understanding how to avoid losing it. This includes developing strong risk management protocols, maintaining detailed trading records, and constantly evaluating and adjusting strategies based on market conditions and personal performance metrics.
