Are there such things as option trading success secrets? That can be debated, but what you should know is that there are ways to improve your odds for success in option trading. Are they necessarily a secret? Probably not. However, most option traders don’t do certain things that could enable them to extract money from the market on a regular basis. Below we will look at a few of the ways you can dramatically increase your odds and understanding of options.
What Is Option Trading?
Trading options can perform certain functions for traders and investors, but there are some things it cannot do. One of the things it cannot do is to perform miracles. Many traders and investors think options can always save a losing trade. Sometimes they can but other times they cannot, and you can definitely lose money (and sometimes a lot) trading them just as you can for equities and futures.
The buyer of an option has the right but not the obligation to buy or sell (sell short) shares of stock or another underlying at a specific price and by a certain time (expiration). Usually, but not always, buyers of options hope to sell the option for more than they paid to realize a profit. Call options give the owner the write to buy shares and put options give the owner the right sell (sell short) shares.
The seller of an option has the obligation to buy or sell (sell short) shares of stock or another underlying at a specific price and by a certain time (expiration) if the owner of the options decides to exercise his or her right (assignment).
Similar to the stock market, there is an options market to buy and sell calls and puts. Unlike buying or selling shares, option strategies can profit from a directional or a neutral bias, which makes them quite flexible.
Option Trading Example
Here is a real and simple example of an option trade. Let’s say an option trader believes XYZ stock will move higher sooner rather than later. The stock is currently trading at $50, and the trader believes it can get to $55 in about two weeks. The trader can purchase a long call option with a strike price of 50 with 30 days till expiration (call it June expiration) for 3.00 or $300 in real terms. If the stock increases in price, the right to buy the shares for $50 a share becomes more valuable thus increasing the premium all other variables held constant. If the shares moved $5 higher, the call option may have increased to 5.50 leading to a potential profit of 2.50 (or $250 in real terms) if the option buyer decides to sell the call. In this case, the option trader did not take shares at $50 a share and just sold the call option.
Is Option Trading a Good Idea?
Options allow you to hedge, use leverage and generate income. Hedging essentially reduces risk. Options can protect individual trades or your whole portfolios if need be. That itself can be the most valuable attribute of options.
Trading options can also provide leverage much greater than other trading instruments. An option trader can choose to use less capital and have more exposure to a stock’s price movement. This can certainly give option traders more overall flexibility especially for their portfolio.
And how can you forget income? Reducing risk exposure should be at the top of the list for every trader and investor, but the ability to increase your overall capital with great leverage is not such a horrible thing either.
How Can You be Successful in Option Trading?
The key to achieving success as an option trader is the same as being successful at any other occupation. You need to be educated and disciplined and have the drive to succeed. You need to write and rewrite a competent options trading plan for yourself and most importantly follow it. Investors who are successful do this. If you were opening a restaurant, you wouldn’t try to do it without a plan would you? But many options traders will never start or finish writing a trading plan.
Before you start writing a trading plan, ask yourself if you are truly motivated to succeed. It may sound insulting to ask that, but traders really need to find out. Will you put in the time to make it as a trader? There are going to be highs and lows along the way. Will you be able to handle those? And will you be disciplined enough to write and follow a trading plan?
Tips for an Optimal Options Trading Day
This section could be chapters and chapters log but I’ll narrow it down for the sake of being brief. Start by doing prep work. Looking at the market as a whole, sectors and individual equities, for example. Consider developing a watch list and adding and subtracting from it over time. Examine implied volatility levels and option chains looking for an edge.
When the market opens, tend to existing positions if need be and look for opportunities to implement new positions as well. Do your due diligence and check for expected announcements as a whole and for the individual equity before taking any trades.
Do you need to wait for a confirmation before executing a trade or is the trade good to go now? Know how you will manage every trade for both profit and loss before hitting that enter button. In addition, consider different contract sizes based on the underlying, market and option strategy.
Do any positions need tending to into the close? Does risk need to be removed and profits realized? When the market does close, consider giving yourself a break and getting away from the computer. We all need breaks and especially days off from the market.
There are some secrets to finding success as an option trader. Most of it comes from you being dedicated and putting in the work to become successful and profitable. Using these tips above can put you distinctly on the right path. Good luck!
Senior Options Instructor
Market Taker Mentoring, Inc.