Options Trading Must-Knows for Beginners

Buying CALLS and PUTS isnot as simple as you think.  CALLS and PUTS are the basic DNA of everyOptions Strategy.  Every single one.  And with countless combinations of buyingand/or selling PUTS and/or CALLS, you might conclude that the simplest thing inthe world for a beginner to focus on first is to simply buy a CALL when you areBullish and buy a PUT when you are Bearish. Easy, right?  No.  Sorry to break it to you, but there is moreto it than that.  You must account forthese factors as well (just for openers):

1)     Options valuesdecay over time.  When your shares ofstock don’t move, you don’t lose money.  When you buy an option on a stock, and thestock doesn’t move, you DO lose money.   You MUST therefore have a strong directionalbias, because sideways is NOT a break-even situation for longoptions.  In fact, if the stock onlymoves in your favor a little bit, but not enough to overcome the time decay,you can STILL lose money.  Not so with stockinvesting.

2)     When the stockprice moves in your favor by one dollar, you make a dollar per share.  On a long option trade, when the stock pricemoves in your favor by one dollar, you do NOT make a dollar per share.  You make less.  A certain number of pennies on the dollar,which can vary based on the option you choose. This fact of life has caused many new options traders to throw up theirhands in disgust when they have a winning trade but are disappointed that theprofits weren’t as big as expected. 

3)     Leverage is atwo-edged sword.  The same leverage thatcan allow for outsized percentage gains can also lead to outsized losses.  It’s extremely rare (or at least takes a verylong time) for a stock to give you a 1000% gain or more.  But it is also extremely rare for a stock tolose 100% of its value.  For longoptions, both 1000% gains and 100% losses are much more commonplace than forstocks.  This is exciting, but alsoscary.

4)     Because ofchanges in volatility, Options prices can sometimes be unusuallyexpensive.  This happens during timeswhen the expectations of bigger faster moves in stocks increases.  Ignore this at your peril!  Nobody likes getting ripped off.

We’ve givenyou the bad news first.  It is certainlynot our intention to chase you away from Options trading because of thetremendous potential benefits.  Let’stalk about them.

Optionshave TREMENDOUS Potential Benefits:

1)     Everyone lovesthe aforementioned large potential percentage gains of leverage, but what thisalso implies is that you can still bring in significant profits with smalltrades in a small account and get by with LESS capital at risk.  Any financial professional who tells you inknee jerk fashion that Options are risky isn’t seeing the whole picture (or ischoosing not to).   

2)     Options canprovide a simple limited risk way to HEDGE individual stocks, or even an entireportfolio.  For example, let’s say that90% of your market exposure is in a 401K account with funds that are largelycorrelated with the overall market.  Whena big bear market rears its ugly head (and it will) your choices arelimited.  While you “wait it out for thelong haul” you still won’t be happy for the time (possibly years) when your401K looks like a 201K.  One solution isto simply buy a long PUT purchased on an index ETF (such as SPY or QQQ) done ina separate options trading account. Buying the right number of PUTS for the given size of the portfolio isimportant.  This will limit your exposureto market downside while you wait for the eventual recovery. 

3)     The FLEXIBILITYof Options is a biggie!   Theunbelievable variety of options strategies means that there are gains to be hadfor the options trader in virtually every kind of market.  Up, Down, Sideways, Volatile, Not volatile,Expecting a big move but don’t know which direction, cash flow strategies etcetc. etc.  Learning Options trading is ajourney not a sprint.  But let thelearning begin now and continue for you for a long time! 

Here aresome Initial Tips to help you get Started with Options Trading the Right Way:

1)      Do not trade with real money until you fullyunderstand both the strategy itself and how to execute it flawlessly on yourbrokerage site.  Sometimes there is nosubstitute for practicing on a simulator without real money at risk.  Practice and prove yourself first with atleast 30 trades per strategy.  Then tradesmall after that.  You can size up downthe road.

2)     Learn about theeffects of volatility.  You want to buyoptions when implied volatility is low (and options are cheap) and sell themwhen implied volatility is high (and options are expensive).   This can give you two ways to win the optionsgame: being right on the directional move of the stock AND being right on thenext move in volatility.   Knowledge ofvolatility could be the single biggest separator between amateurs and pro-leveloptions traders.  Trading Academy canmake this easy with a proprietary volatility gauge:

3)     Avoid Optionsthat expire very soon and will require a huge move to make any real money.  Better to buy more time than you need for theexpected move than to not buy enough. Sometimes you get what you pay for.

4)     Invest in youreducation.  To learn a step-by-stepmethod for picking a stock direction and trading options, visit us atwww.tradingacademy.com