Profitable Stock Option Trading With the ThinkOrSwim Platform

Updated on February 17, 2020
Glenn Stok profile image

Glenn Stok writes about investment and risk-control strategies that he has perfected during 45 years trading stocks, options, and futures.


This article is for those who have at least some experience with options trading and willing to learn something new.

After more than 30 years of trading stocks and options, I found the most dependable method of managing trades is with the ThinkOrSwim platform that's included with a TD Ameritrade account.

This trading tool shows all the critical market information that helps increase the odds of finding successful trades. However, a full understanding of the data is necessary to put it to use with proper trading methods. I'll discuss that in this article.

Using ThinkOrSwim to Sell Premium

Many people I talk to don't understand that we can sell something we don't own? Selling premium is just that!

You sell premium by selling options on stocks with high volatility.

You might be wondering why people are willing to buy that option from you, especially when it's far out of the money?

The buyer is buying the option from you with hopes the underlying stock will move swiftly in the direction he or she thinks it will—to make a quick profit. The problem with that strategy is that his or her timing might be off. They have to be right within a short time-span because the option loses value. But that helps you are the seller. Their loss is your gain.

Most people lose when they buy options because it loses value as it gets closer to expiration. That's why you are better off with being on the selling side of the trade.

ThinkOrSwim provides all the tools to manage trades with selling premium using various options strategies. It even helps us find the best spread to increase the probability of profit (POP).

So, with that preliminary explanation, let's get into the nitty-gritty.

Stocks are risky. But risk can be controlled with options.
Stocks are risky. But risk can be controlled with options. | Source

Effective Methods of Trading Options

When buying stocks, there is always a 50/50 chance of success. A stock can only go up or down. With only two possible results, it’s a 50% chance of success.

Stock options, on the other hand, provide the opportunity to improve the odds since there is more than one way to have a profitable trade. With the proper strategy, you can be wrong with the direction and still make money.

Uneducated traders think that options are dangerous and that one can lose all their money. They say options lose value quickly and expire worthless.

All this is true, but that’s the beauty of it.

If one knows how options work, they can be used to make money with much less risk than with stocks.

A complete understanding of what I’m about to discuss requires knowledge of the terms I’ll be using. If you don’t know what option premium erosion is, or option Greeks, or implied volatility, don’t feel bad. Many options traders don’t fully understand these things either.

I hope that will not deter you from using your intelligence to make the best of this article. Just ignore anything you don’t understand. You will still grasp the crux of what I’m saying. I assure you. I know you can do that.

A Note About Options Strategies

There are many strategies used to trade options, such as Iron Condors, Calendar Spreads, Butterflies, Straddles, and Strangles. I will only be using Spread Trades in this article since my focus here is with the rules of success rather than the types of strategies.

I learned some rules that made all the difference with my success. When you follow these rules, you'll improve your chance of profit considerably:

  1. Sell options when Implied Volatility Percentile is high.
  2. Buy options when IV Percentile is low.
  3. Define your risk when entering a trade.
  4. Manage winners mechanically, not emotionally.

If these terms sound foreign to you, consider the fact that many options traders don't understand them either. I'll explain all that as we move on.

The Process of Selling Option Premium

The idea is to sell worthless options to people who are willing to pay a premium for them. When the trade is appropriately adjusted, as I’ll explain later, it leaves a 68% chance of expiring with a profit.

Remember, buying stocks has only a 50/50 chance of a profit. Additionally, when you buy a stock, you are risking all your money. But selling option premium can be achieved with defined risk. Let's get into that.

Risk is defined by buying an option further out of the money for much less than the premium received.

An analogy will make this clear:

You sell an option to someone who wants to buy it for one of two reasons:

  1. They think it will move in their direction by a certain amount within a specific time. That is pure gambling. But you are on the other side of the trade, and it’s always in favor of the house. And YOU are the house.
  2. They buy a PUT option as insurance against loss on a stock they own. Or they buy a CALL option as insurance to be able to buy a stock at a particular price.

Either way, you are selling insurance, and you keep the premium if things don’t go in favor of the buyer.

Stay in the game even when you are wrong!

How to Define Your Risk

Note that I'm not talking about buying options. Options lose value over time. Buying options in hopes of picking the correct direction is a loser’s game.

What I am talking about is selling premium, not just selling options. That’s another mistake uneducated options traders make. They sell options thinking that they get to keep all the money when the option expires worthless. That works only until the day that you bet wrong and get a margin call from your broker.

However, selling with defined risk allows you to stay in the game even when you are wrong.

You can never get a margin call because you have established how much you risk when you enter the trade. It can’t ever get worse, no matter how wrong you are.

So, staying in the game offers a great opportunity. When you are wrong, you can roll a losing trade forward another month, sometimes with a credit. That credit reduces your cost-basis.

How to Set Probability of Profit (POP)

When you enter a trade with the strict rules that I'll explain below, it will be profitable 68% of the time.

  1. You need to look for a stock that has options trading with an Implied Volatility Percentile higher than the average for that stock.
  2. Options you consider should be expiring in roughly 20 to 50 days. That is the best period to realize a profit from theta decay. (Theta is one of the option Greeks that help so much with doing things right).
  3. You need to sell an option more than one standard deviation away from the present stock price. That will have a Delta of 20 or less. (Delta is another of the option Greeks. The ThinkOrSwim Platform makes this easy).
  4. You need to define your risk by buying insurance. How? By buying a similar option further out of the money. That's known as a spread trade. It's the spread between the option you're selling and the protective option you're buying. It does reduce the premium you receive, but it locks in (or defines) a maximum risk.
  5. You need to take a credit of at least 1/3 the spread. Remember that you’re selling, not buying. So you get a credit for the trade.

Example: If the spread is $10 between the option you sell and the option you purchase for insurance, then you want a credit of $3.33. That’s 1/3 the spread. So you risk $10 to make $3.33.

After commissions, let’s make it an even $3. So if you want to make $300 profit, you risk $1000. (When can you make $300 on a $1000 stock investment in one month?)

How to Manage Profit

There are two things you can do to manage your success rate and increase profits beyond 68% POP.

(1) Rather than sell premium one standard deviation from the strike price, go out two standard deviations.

The ThinkOrSwim platform makes it easy to find where we can sell premium at one or two standard deviations away from the stock's present trading price. Selling premium two standard deviations away raises your probability of profit to 95% because there is only a 5% chance the stock will move that much within the particular timeframe.

(2) Rather than waiting for a trade to expire so that you keep 100% of the premium received, take profits when you have a 50% gain or higher.

If you wait for a home run, it can turn against you due to volatility. Besides, closing a trade sooner frees up the risk so that you can enter new trade when you find another good opportunity.

Someone once said, “I never lost money by closing a trade too soon.”

Taking profits when you have only a 50% gain can improve overall success.
Taking profits when you have only a 50% gain can improve overall success. | Source

The Rules of Success With Options

Pay Attention to Volume of Open Interest

ThinkOrSwim has valuable tools. For example, you can check the open interest at the strike prices you plan to trade.

If you find a seemingly good trade with a high Probability of Profit (POP), check the open interest at the strike price first. If there is no volume in it, then the bid/ask spreads are too wide, and it's best to stay away from those trades.

No matter how great the trade looks, it isn't good if nobody is buying or selling.

Stay Small

You need to limit yourself to small trades so you can stay in the game until the trade comes to you. It's rare to enter at the right time.

Most likely, a trade will initially go against you. But if you keep it small, you'll be able to wait for it to come back. Selling premium has a better chance for that to happen since premium erodes with time.

Trade Only High-Volume Stocks

Stick with only high volume stocks or futures. ThinkOrSwim is excellent for showing us the volume. I also look at the delta on ThinkOrSwim to know the probability of profit.

A Delta of 5 has a 95% chance of success. I never sell premium on anything less than a delta of 10, which still has a 90% chance of POP.

When you're on the other side of the trade, the odds are in your favor.
When you're on the other side of the trade, the odds are in your favor. | Source

Learn From Your Mistakes

When you have losses, examine how you entered the losing trade.

When I do that, I see what I did wrong, and I avoid repeating the same mistake.

The best method is entering trades two standard deviations away. When I'm greedy and sell within one standard deviation just to make more money, I usually get burnt. But even in those cases, I buy more time by rolling forward until I get back to break-even.

Eventually, you might get your money back even when you're wrong. However, the better plan is to avoid those trades that have a lesser POP and not be greedy. You will make mistakes, but keep track of when you win and when you fail. Then you'll have something to look back on to see why you have specific patterns.

Admit When You're Wrong

When you have a bad trade that's going way against you, consider rolling forward at break-even or a small credit.

You could be right and just have the timing wrong. So buying more time gives you a second chance. And usually, you can roll at a credit because there is more premium another month out.

There is no cost of buying more time. You're just holding your risk for another month. The main thing is that you need to admit you are wrong in the short term, and you need to make adjustments.

The Most Important Rule

If you can’t enter a trade with all the parameters I mentioned earlier, move on.

Many people try to squeeze out a bad trade out of greed. Or they simply don’t pay attention to all the rules. I'll admit I've made those mistakes. Try to be better than that.

If you can't enter a trade with all the correct parameters, just wait for another opportunity. There will always be another chance for a trade that works. The beauty of ThinkOrSwim is that it shows you all the parameters needed to know if it’s a good trade or not.

When you stick to making good trades, you will be in the 68% category. Sure, you will lose 32% of the time. But I like those odds.

This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.

Questions & Answers

  • I am new to options and I have trouble for a call credit spread. How do I close out the position. I get pretty confused and I am not sure if I am making my profit. Can you help me with that?

    A CALL credit spread means that you sold an option to get premium and bought another further out of the money at a lower price to protect yourself and lock in a maximum loss. You received a credit because the option you sold was more expensive than the one you bought. You’ll have a profit when the value of the short option (the one you sold) loses value, The long option will lose value too, but it doesn’t have much left to lose anyway, which is why you have a better than 50/50 probably of profit. Even 68% POP if you did your spread well.

    Now, to close the position, you simply buy back the short CALL and sell the long CALL. The cost of closing the trade should be less than the credit you received, leaving you a profit.

    If the trade went against you, you would be paying more to close the trade. But another way you can handle that is to roll the trade forward to the next month, usually with a credit. That would buy you more time.

    Remember, option premium erodes over time, so you eventually should have a profit buying back at a lower price as long as the underlying stock doesn’t have an extreme move.

© 2013 Glenn Stok


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    • Glenn Stok profile imageAUTHOR

      Glenn Stok 

      3 months ago from Long Island, NY

      Pat Patel - If you want to see a sample trade, I described one in detail in another article.

    • profile image

      Pat Patel 

      3 months ago

      Very good tutorial and articles . Please do some samples trades and examples for newbies . It just helps



    • profile image

      Tahir zaf 

      4 months ago

      Excellent tutorial and article on how to play options in a disciplined way . There should be follow up sessions with some sample trades

      Many thanks

    • TheDigitalOption profile image

      Justin Delano 

      6 years ago from Everett

      A very solid introduction to the subject. It can be a bit overwhelming at first, I know it was for me years ago. Cheers!


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