Six Things to Remember When Trading OptionsIt is often said that trading options is risky and fraught with unknown dangers, it’s difficult to
learn and difficult to do. This isn’t always the case.
As with any kind of trading it’s essential to have solid risk management skills. But provided
the trader is trained correctly from the start and has a thorough understanding of options
themselves as well as probabilities and time horizons, profitability is possible, even when
there aren’t any stops.
Here’s 6 things to remember when trading options:
1 - It’s important to question whether your expectations for the underlying stock hitting the
breakeven point are realistic and to do your scenario calculations before you put your trade
on.
2 - Don’t forget that directional bias (long or short) can be used to set up great option
trades.
3 - A common mistake is not to check the expiry date of the options and then select the
wrong strike prices. People tend to place option trades without calculating the risks and
end up throwing their money away.
For example a trader might put a US$50 on a $200 call that expires in a month but if it is
currently trading at $80 then it might need a lot more time and the option contract will
expire worthless – unnecessary money lost.
4 - Another trap is to think that there is a value in buying an option just because it is cheap.
In reality, you always need to look at the risk scenarios, calculate the likely outcomes and
decide which is best in terms of strike price selection and for you as a trader.
5 - Never trade naked options no matter how alluring it may seem. All your assets are on the
line when you sell an option and don’t own anything that can cover you if the trade goes
against you. That said, selling options does have its place as part of multiple strategies that
provide coverage, for example covered calls and option spreads. But only when you have
solid risk management skills in place.
6 - Anyone new to trading or trading options should avoid option selling strategies until they
are experienced and profitable trading buy only strategies.
The benefits to options
There are particular benefits to trading options. For example, they suit people who want to
trade while also working a full-time job as options trades run for days and weeks as opposed
to intraday trades that run for minutes therefore requiring more time each day.
Also you don’t have to tie up a lot of your capital in each trade and it’s a defined risk, at
least with buy options where you can’t lose more than the premium paid for the option.
This can be attractive to the new trader as options are a lot less capital intensive than
buying stocks.
So it’s about applying the same rigour and willingness to learn to this type of instrument as
you do to any other.
