The Best Automated Options Trading Strategies

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Contributor, Benzinga
May 25, 2023

Options trading is a great way to diversify your portfolio, but it takes a lot of time to look at charts and manage them yourself. Emotions can get in the way and take you away from your family, work and other life activities. What if you could get the returns from options trading without spending as much time doing research or looking at your portfolio? Automated options trading makes it possible. Artificial intelligence (AI) does the trading for you based on parameters you get to decide. This article will reveal automated options trading strategies you can use to earn from your portfolio without having to check stock prices every minute.

What Is Automated Options Trading?

Automated options trading, also known as algorithmic trading, does the trading for you. You won’t have to worry about picking options or sticking with your exit plan. Human errors and emotions can get in the way of good returns, and automatic options trading gets rid of those elements of trading.  You can step away from your portfolio knowing the algorithmic trading platform is buying and selling stock options based on your preferences.

Why Choose Automated Options Trading

Taking human emotions out of the equation is one of the many advantages you can experience with automated options trading. An automated approach lets you implement multiple trading strategies in real-time. If you set your exit prices at 20% above your cost basis, the algorithm will sell your option the instant its value surpasses 20% of the price you purchased it. Automated options trading covers multiple markets and has historical data that guides its decisions. Spreads let you enter the market quickly and get more exposure to options instead of manually waiting for your bid price to get accepted.

8 Strategies for Automated Trading Strategies for Options

Options traders can incorporate several strategies with their algorithmic trading platform. You can get started with these choices.

Momentum Investing

Momentum investors look at a stock’s current direction and volume. If a stock has been rising for a few days and still has high volume, it can signal that more gains are ahead. Investors can buy calls during bullish sentiment and buy puts when a stock looks bearish. 

Mean Reversion

Investors following mean reversion believe that a stock will return to its average price, even if it is currently overbought or oversold. Under this philosophy, an overbought stock will fall to its mean, representing a bearish opportunity. Oversold stocks should rise back to their mean over time. While new means can get established as a stock continues moving and fundamentals can change, mean reversion is a good resource to have in your trading toolkit.

Arbitrage

Arbitrage seekers look for two nearly identical assets with different valuations. The trader seeks to buy several shares of the stock with a lower valuation and wait for it to reach the valuation of the stock with a higher value. Investors narrow their search to companies in the same industry with similar earnings growth, opportunities and valuations. Arbitrage is more common with forex markets, but algorithmic trading helps investors capitalize on arbitrage in the stock market.

Mathematical Model

Mathematical models look at historical market patterns and price movements to predict what is likely to happen in the present. Algorithmic trading platforms can help you generate these mathematical models and use them to make trades.

Trend-Following Strategy

Trend-following traders look at lines of resistance and support. They seize breakout opportunities in either direction and ride the current trend. If a stock breaks past a resistance line, it’s bullish and can present a buying opportunity. Stocks tend to become bearish if they fall below their lines of support. Trend-following strategies rely on technical analysis to determine entry points.

Synthetic Options Strategy

A synthetic option mimics a long call or put while lowering risk. Traders can use synthetic calls and synthetic puts to lower risk and still capitalize on stock price movements. A synthetic call requires a trader to buy 100 shares and then buy a protective put that is in the money. A synthetic put setup requires an investor to short 100 shares and then buy a long call that is in the money. Synthetic positions protect the long position from depreciation. Some investors use synthetic options to protect themselves from short-term price fluctuations because of earnings reports and other notable events that can significantly impact the stock price.

Seasonality Strategy

Traders who apply seasonal strategies look at historical returns for each month and quarter to determine their positions. These traders know that September typically produces the lowest returns of the year and that the end of the year minus tax harvesting in December produces better returns. Some investors embrace the mantra of “Sell in May and go away.” Stocks tend to perform worse from May to October and do well from October to May. While seasonality is one of many factors, there is historical precedent for the sell-in-May approach.

Index Funds

Buying index fund options is a less risky way to get started. These prices are not as volatile, and since they measure the market, you are less likely to encounter outliers. Options traders can prepare for a bearish market with put options, but some individual stocks can soar in the short term even as the indexes fall.

Accuracy of Automated Options Trading

Automated trading does not offer guaranteed returns. It has risks like any other investment, but these algorithms let you use backtesting to see how your criteria would perform. Backtesting lets you measure performance before you trade options and build positions. You can use backtesting and optimize your strategy to increase your accuracy with every trade.

Automated Options Trading vs. Stocks and Other Commodities

Automated options tend to have fewer risks since an algorithm handles the trade. An algorithm doesn’t get caught up in the excitement of an earnings report or other dramatic event. An automated options trading broker fulfills your criteria and knows when to enter and exit positions based on your parameters. Trading stocks and commodities on your own makes each trade more vulnerable to emotions and human error. While automated trading can present less risk, it involves more factors. Algo trading has a learning curve, but once you become familiar with the basics, it gets easier over time. 

Options Trading Simplified

Automated options trading is a simplified approach to getting started. You can use criteria to make investments and use backtesting to see how your parameters would have performed in the past. Having this context can help you make better decisions with your funds without spending hours in your portfolio every day.

Frequently Asked Questions

Q

What is one of the most-used strategies for automated trading?

A

Trend following, mean reversion and arbitrage are popular automated trading strategies, but those three strategies are the tip of the iceberg.

Q

Is automated trading profitable?

A

Automated trading can be profitable. You can save money on each trade and not let emotions get in the way of winning trades.

Q

Is it hard to learn algo trading?

A

Algo trading has a learning curve like any other investment strategy. Some platforms make it easier to learn algo trading and help you understand the basics.