Those looking for option trading advice are usually either fairly new to the options market, or are experienced traders having some difficulty with their current trades and are hoping for an answer. If you are among the first category you are probably looking for some advice about how to start options trading, what risks are involved and how to avoid them, how to trade safely and still make consistent profits. If you are among the second category, there are ways to save or at least, salvage, losing trades, but this discussion must be left for other pages on this site.
The simple answer is, to make sure you first understand all there is to know about options trading, particularly the principle of time decay, before you risk any of your hard earned money. Decide what kind of trader you wish to be. Do you want to be a day-trader, a short term trader or a longer term trader who only needs to check your positions to see if you need to adjust them once a day and has at least a monthly or longer strategy in place.
The next question you should ask is, what underlying financial instruments do you wish to connect your options to? Stocks, commodities or foreign currencies? Whichever one you choose, they each have their own set of characteristics. For example, stocks can 'gap' overnight between trading sessions. Commodities can become very volatile. Currencies trade around the clock five days per week and are affected by economic news items.
Understand also, that the shorter timeframes you intend to trade, the higher the stress and if you hold your positions overnight, the greater risk of losing trades damaging out your account.
The Dangerous Way to Trade Options
In giving option trading advice, we would be remiss if we didn't bring to your attention the fact that, like any business, there is a high risk and a low risk way to do it. If your intended strategy is to simply buy call or put options in an attempt to predict short term market direction and profit from these moves within a few days, you should understand that although this carries a potential high reward profile which makes it appealing, there is also a much greater risk that the price will go against you so that your losses can quickly outweigh your profits. Many traders who try to predict short term market direction have cleaned out entire trading accounts.
You may believe you have found an option trading system that works for this type of strategy. But if you want some real option trading advice here, you should ask yourself whether you have the personal self discipline to take stop losses as well as stay in trades long enough to realize desired profits. Do you have enough free time to be able to concentrate and act when the need arises? The high risk way of trading options often seems appealing to new traders due to the simplicity of its approach and the optimistic prospect of making big profits. But even well seasoned traders find market prediction difficult, so beware of systems that promise you the moon.
The Low Risk Way to Trade
Now here is the best option trading advice you may ever receive. If you understand the principle of time decay, you should learn how to use this to your advantage. Out-of-the-money options experience this phenomenon due to the one certainty that comes with all options - they eventually expire.
It is far better to be on the selling side of an option contract than the buying side, due to this feature of options. Taking positions with about a month or slightly more to expiration date and being on the selling side of option contracts puts you at a distinct advantage.
But you also want to add to this advantage, the art of adjustments. Even with the advantage of time decay on your side, the underlying price movement can come close to breaching your breakeven points before option expiration dates and this is where you need to know what to do. If you adjust your positions correctly at this point, using the option greeks as your guide, you not only save them from loss but guarantee further profits in the process.
In connection with the above strategy, you should consider
trading indexes instead of individual stocks. The reason for this, is
that you prefer a smooth price movement to a volatile one. While a news
item may unexpectedly the price of an individual stock it will not have
much affect on the index to which that stock is related. An index is the
aggregate of a group of stocks such as the Dow Jones, the Russell 2000,
the Nasdaq 100 or the S&P500 in the USA. Options are available on
all these indexes. However, I would advise that you trade their respective ETF's such as the QQQ and the SPY instead of the indexes directly.
Trading double calendar spreads and iron condors on indexes and knowing how to adjust your positions when necessary, is one of the best trading methods I have found. My option trading advice to you is to at least familiarise yourself with these and allow yourself to trade with confidence.
Return to Explain Option Trading Contents Page
Go to Option Trading Homepage