- Step 1: Universe Selection
The first step in my mechanical options trading system is universe selection. This involves choosing from a database of approximately 200 stocks and ETFs, focusing specifically on the most active 60 to 70. High liquidity and tight bid-ask spreads are essential for successful trading. It is crucial to avoid penny stocks or low-volume options, as the math does not work in these scenarios. Instead, I recommend sticking to well-known stocks like Apple, Microsoft, SPY, and QQQ. This approach is not about finding the next hot stock; it is about trading in environments where the math consistently works in your favor.
Step 2: Volatility Assessment
The second step is volatility assessment. I look for elevated implied volatility using the options chain, without the need for charts. High volatility indicates higher premiums, making it an ideal time for selling options. My goal is to identify situations where the market is pricing in more movement than is likely to occur. Since volatility is mean-reverting, I sell options when volatility is elevated to capitalize on the expected decrease.
Step 3: Probability Calculation
Next, I focus on probability calculation using one standard deviation. The options chain reflects the market's opinion on where a stock is likely to be. By using one standard deviation, I can determine that there is approximately a 68% probability of the stock staying within that range. For example, if Apple is trading at $180 with a $10 standard deviation, there is a 68% chance it will remain between $170 and $190 by expiration. By selling options outside of this range, I can achieve a 68% chance of winning, which can increase to over 70% with proper management. This step is purely mathematical, eliminating guesswork from the equation.
Step 4: Strike Selection
The fourth step is strike selection. I choose strike prices based on the probabilities calculated in the previous step, typically around the one standard deviation level. The objective is to balance meaningful premium collection with a high probability of success. Selecting strikes that are too close to the money may yield higher premiums but lower probabilities of success, while those that are too far away may not provide sufficient premium. This process is mechanical and guided by mathematical principles rather than intuition.
Step 5: Position Sizing
Position sizing is perhaps the most critical step in my system. I advocate for trading with a small size while executing many trades. This approach can be likened to flipping coins; a few flips may yield skewed results, but many flips will approach a 50/50 distribution. I never risk more than 1 to 2% of my account on a single trade, but I may have 20 to 30 positions open simultaneously. This strategy leverages probabilities to work in my favor over time, allowing for consistent and sustainable profits.
Proof and Credibility
The effectiveness of this system is evidenced by my consistent win rates of over 70% for the past 20 years. This success is not due to any special skills or intelligence; it stems from adhering strictly to the process. You do not need to be a math genius or predict market direction; you simply need to follow the system. This is the same approach I teach in my membership program, where members can see every trade I make in real time along with the reasoning behind each decision.
While many alert services exist, our system achieves mechanical profit targets in 75% of trades. The remaining 25% of trades that encounter challenges require experience and proper management. I share real-time trades with my gold-level membership, and I encourage anyone interested to explore this opportunity.
This five-step mechanical options trading system is designed to build consistent, sustainable profits over time rather than offering a quick path to wealth. I invite you to ask any questions you may have about this system in the comments, and I will be happy to respond to each one. Remember, success in options trading is about following a proven process and managing risk effectively.