Options: 10 Trading Tips
mathemagician and Thread,
Here is an excellent list of Option Tips posted on Didi's Wings-FPT thread this morning. I've slightly edited the format. I'm please that we've discussed about every one of these at one time or another.
Message 16119944
In the end, #10 summarizes what we encourage here:
"Trading options is learned by developing a market forecasting technique, by starting small, by realizing profits and losses and by working at a steady pace. Traders should be able to explain their trade-selection process in a few sentences. Beginners should enter trades that have only small potential profits or losses, because this will increase the chances that objectivity can be maintained."
--fl
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Options: 10 Trading Tips
By James Bittman, Senior Instructor, The Options Institute at The CBOE
1. Know the difference between using options to speculate and using options to invest.
Speculators are pure traders, short-term market timers with little interest in the underlying stock, and they often use a high degree of leverage.
Investors, however, use options to buy, sell, protect, or increase income from stock positions, and investors do not use leverage.
2. Investors who use options need a plan.
Will a purchased option be exercised or sold if it is in the money at expiration?
Covered writers must know whether or not they are willing to sell the underlying stock;
...if not, at what price will the call be repurchased or rolled to another option?
Put writers must know whether or not they are willing to buy the underlying stock;
... if not, at what price will a short put be repurchased, even if at a loss?
3. Option traders need a three-part forecast:
... for a specific price change in the underlying,
... for a specific time period and
... for a specific change in implied volatility.
Developing a forecasting technique is a challenge for all traders, but trading options is unique because of the multi-part forecast that options require.
4. Option traders need discipline in taking profits and losses.
First, have a profit target and close or reduce the size of a position if that price is reached.
Second, have a stop-loss point and close or reduce the size of a position at that price.
Third, have a time limit and close or reduce the size of a position if neither the profit target nor the stop-loss point are reached by the end of the time period.
5. Option traders need to understand and pay attention to implied volatility.
Implied volatility is the volatility percentage that justifies the market price of an option.
Volatility in options corresponds to the risk factor in insurance, and implied volatility reflects the market's perception of the risk, or potential price range, of the underlying stock.
6. Implied volatility has no absolutes.
Option users must develop a subjective feel for what are "high" and "low" levels of implied volatility.
7. "Buying under-valued options" and "selling over-valued options" are not sufficient strategies.
"Value" is a subjective determination that every trader must make individually.
Option traders must focus on their three-part forecast as much as or more than the "value" of an option.
8. "Selling options" is not a better strategy than "buying options."
It is a myth that 80-90% of options expire worthless.
Approximately
... one third, or 33%, of options expire worthless,
... while 10-15% are exercised.
... The rest are closed prior to expiration.
9. Trading means buying and selling.
It does not mean buying and holding.
The goal of trading is make a net profit after a series of trades.
It is, therefore, essential to accept some losses and to look forward without chastising oneself for making mistakes.
10. Trading options is learned by developing a market forecasting technique, by starting small, by realizing profits and losses and by working at a steady pace.
Traders should be able to explain their trade-selection process in a few sentences.
Beginners should enter trades that have only small potential profits or losses, because this will increase the chances that objectivity can be maintained.
Trades must be initiated and closed so that a "trading rhythm" is developed.
Almost anyone can learn to trade if they spend a few hours every week developing their technique. |
