So You Want to Learn How to Trade Options
Congratulations! You’ve made a great choice.
Learning how to trade options can be one of the most profitable and satisfying skills you will ever acquire. The trick however, is to understand clearly that it is not all plain sailing. There are dangers for bright eyed novice traders, which if disregarded, can so easily bring about their undoing and with it, the disillusionment and cynicism that typicially accompanies those who have tried and failed.
There are many ways to trade options and in the end, you need to choose the way that most suits your personal style and circumstances. For example, there is day trading – this is the “fast and furious” way of trading. It can be done – and many do it successfully – but are you the type of person who can make decisions quickly and dispassionately, even if it means accepting a loss and moving on? And you may do that a number of times a day.
Then there is short term directional trading. You buy a call or put option depending on whether you believe the underlying is about to rise or fall in price, stay in the trade for a week maximum and hopefully exit with a nice profit. This can be immensely profitable if you get most of your trading decisions right. I knew a guy who made 25 consecutive profitable option trades and did very well for himself. But he was a “super trader” and master chartist. You may not be so fortunate. Can you handle losses? Do you have the time and opportunity to check charts and options prices whenever you wish? If you’re holding down a “day job” this may not be easy – and that’s often when you can lose money trading this way.
Learn How to Trade Options the Safe Way
But there are other more exotic ways of trading the options markets. You see, the beautiful thing about option derivatives is, that you can not only buy them, but you can also create them out of nothing and then sell them. This is called short selling. When you buy an option, you go “long”; when you “sell to open” an options position, you go “short”. Now here’s where it gets interesting. You can construction combinations of long and short options positions, with either the same, or different, expiration dates – these are called options strategies – and each different strategy becomes profitable under different market conditions.
Here are some example of what “different market conditions” means:
Range Trading Strategies – this is when you anticipate the underlying security (stock, ETF, index, forex pair, commodity future) will remain within a given price range up until the time your front month options expire. Providing the underlying remains within the price range, your positions will make a profit. Even when it doesn’t, you can still adjust your positions to maintain profitablity.
Non-Directional Strategies – due to the way option prices change in response to movements in the markets, you can construct positions that can become profitable whichever way the underlying moves. You don’t really care which way it goes – up or down – as long as it goes somewhere and within a reasonable period of time. These are sometimes called “delta neutral strategies”. The profit from the winning position is large enough to cover the loss on the losing position and then some. But there are some very clear conditions that need to be present before you charge into these trades. Your greatest danger is the “time decay” factor that accompanies all options contracts. All options eventually expire and as that inevitable date draws near, the rate at which some options expire increases exponentially.
Spread Trading Strategies – an options spread is a combination of a bought and sold position, each leg of the spread being at different strike prices. So you might buy 10 call options in a stock at $25 strike price and simultaneously sell 10 call options for the same stock but at a strike price of $30. You now have a spread! It has two ‘legs’ being the bought and sold positions. The beauty of spreads is that they are cheaper to enter than a single call or put position, but they can make just as much profit in the short term, if the underlying moves in your favour.
You can choose whether your spread will be a “debit spread” or a “credit spread” – and this will depend on which of the strike prices you buy and which one you sell. Debit spreads use up funds from your brokerage account, but once done, that will be the limit of your risk. Credit spreads are a bit more subtle – you receive funds into your account (the credit) but you also incur a margin requirement which may limit the extent to which you can use the rest of your funds for other trades. Nevertheless, credit spread have greater flexiblity in terms of adjustments should the trade become unprofitable.
Learning how to trade options can be a fascinating journey. There is so much to understand if you truly wish to become a good trader. But if you take the time and educate yourself you will be well rewarded.
So please take a look around by navigating to any of the topics in the sidebar that take your interest. Or you can simply scroll down and navigate from the main pages listed below, to subtopics that interest you.
HOW TO TRADE OPTIONS – Chapters
1. Explain Option Trading
Need someone to explain option trading to you? Here are the essential things everyone should know about this fascinating subject.
2. Covered Calls
These are considered one of the safest option trading techniques available today. Here we define them and explore the best techniques.
3. Option Trading Strategies
The best option strategies in some cases are a well kept secret. Let’s explore the more popular ones and some others which most have never heard of.
4. Option Trading Systems
There are many options trading systems out there and their promoters will always tell you that theirs is the one that will solve your financial problems and give you the freedom you’ve dreamed about.
5. Option Spread Trading
Option spreads provide many advantages and add flexibility – from the simple debit or credit spread to more advanced strategies such as calendar spreads, butterflies, iron condors and ratios.
6. Index Options
These are one way of trading the major stock market indexes, only with greater leverage on your investment. The good thing about indexes is that they are generally much more stable than individual stocks.
7. Forex Options Trading
Forex options allow you to trade options on currency pairs. Here we explore the different ways to do it, plus some exciting strategies.
8. Commodity Options Trading
Commodity Options are options on commodity futures. You receive all the benefits of leverage on profits but without the same risk as futures carry.
9. Options Trading Software
Some option trading software packages are focussed on picking good entry signals while others are more analytical – providing risk graphs and features like Elliot Wave analysis.
10. Options Broker Reviews
These broker reviews will evaluate the following: Fee structure, trading platform capabilities, level of information about securities traded and bonus services provided.
11. Stock Chart Analysis
In order to be a good options trader, some technical analysis skills should form a major component of your decision making process. Technical Analysis must become an art more than a science.