By Owen Trimball
Those of you searching for option trading advice tend to be either a novice to the options market, or are experienced traders experiencing some problems with their active trades and therefore are hoping for a solution. If you happen to with the first group perhaps you are trying to find some advice about how to start out options trading, what risks are involved and how to prevent them, the best way to trade safely and still make consistent profits. Should you be among the second group, there are ways to save or at least, salvage, failing trades, but this discussion must be left for another article.
So what is the most helpful option trading advice for beginners?
The simple answer is, to be sure you first understand all there is to know about options trading, especially the principle of time decay, before you decide to risk any of your hard earned money. Decide what sort 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 look at your positions to determine if you need to adjust them once daily and it has at least a monthly or longer strategy in place.
The next thing you might want to ask is, what underlying financial instruments do you prefer to connect your options to? Stocks, commodities or foreign exchange? Whichever one you select, they each have their unique set of characteristics. Stocks can ‘gap’ overnight. Commodities may become very volatile. Currencies trade around the clock five days per week and are also affected by economic news items.
Understand also, that the shorter timeframes you are going to trade, the greater the stress and if you hold your positions overnight, the more risk of losing trades hurting your account.
The Dangerous Way to Trade Options
In imparting 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 also a safe method of doing it. If your intended strategy is to merely buy call or put options in an attempt to predict short term market direction and profit from these movements in just a few days, you should understand that even though this carries a possible 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 be greater than your profits. Many traders who attempt to forecast short term market direction have cleaned out whole trading balances.
Perhaps you may believe you’ve discovered an option trading system that works for this kind of strategy. But if you want some real option trading advice here, you ought to ask yourself whether you have the emotional self discipline to take stop losses and also remain in trades for enough time to realize desired profits. Do you have enough free time to be able to completely focus and take action whenever the need arises? The risky way of trading options often seems alluring to inexperienced traders due to the simplicity of its approach and the confident prospect of making considerable profits. But even well seasoned traders find market prediction challenging, so watch out for systems promising you the moon.
The Low Risk Way
Now here is the best option trading tip you might ever receive. If you understand the principle of time decay, i suggest you learn how to use this to your advantage. It is more advantageous to be on the short side of an option contract compared to the long side, due to this characteristic of options. Taking positions with about a month or slightly more to expiry date and being on the selling side of option contracts gives you a clear advantage.
Even so you should also add to this advantage, the art of adjustments. Despite having the advantage of time decay working for you, the underlying price movement can come close to breaking through your breakeven points prior to option expiry dates and this is where you have to know what to do. If you adjust your positions in the right way at this point, you not only save them from loss but guarantee additional profits at the same time.
In connection with the above strategy, you should consider trading indexes as an alternative to individual stocks. The reason behind this, is that you prefer a smooth price movement to a volatile one. While a news item may unexpectedly impact the price of a particular stock it won’t have much affect on the index to which that stock is related. An index is the aggregate of a selection of stocks such as the Dow Jones, the Russell 2000, the OEX, QQQQ or the S&P500 in the USA. Options are available on all these indexes.
Trading double calendar spreads and iron condors on indexes and knowing how to modify your positions at the appropriate time, is one of the best trading techniques I have encountered. My option trading advice for you is to at least familiarise yourself with these and enable yourself to trade with confidence.
About the Author
Owen has traded options for many years and writes for Options Trading Mastery, a popular site about the best Option Trading Strategies. Discover a wealth of information about options, including the popular iron condor
