Getting Started in Option Trading

What you should know before getting started in Option Trading

A question that is often asked on search engines is "What is Options Trading". As the subject has recently been given a higher profile in the media, and as the stock market fluctuation have badly damaged 401(k) and retirement plans, investors are starting to look at other ways to grow their portfolio. Options trading is a broad field that contains plenty of strategies, with all levels of risk profile, and so a serious trader really needs to take a serious look at the possibile strategies available. Unfortunately, the first word that most investors hear is that "Options trading is risky". Is this true? Here are some things that you should know before getting started.

  • Options trading is less risky than trading stocks. Face it: the "buy and hold" stock trading strategy is dead, or it should be! Too many people had their retirement plans wiped out in the recent stock market crashes. It will take many of them years to recover. Is this not the truly risky strategy? Options trading is mostly short term, and takes advantage of both upward and downward trends in the market. There are several options trading strategies that offer a much lower risk profile than "buy and hold", and at a conservative level can still grow a profile by 5% per month. For example, one of my favourite strategies in active trading of credit spreads: it takes about two hours per week, takes very little technical analysis, and I average between 10 and 15% growth on my portfolio per month. Do the math: using this approach, I grew my portfolio from $5,000 to $100,000 in just over two years! Go here if you want to see what I did in just one month. This is not a one-off - I do this every month, and have done so for a few years.
  • Options trading is risky. The big problem with options trading is not the inherent risk in the strategy, but in the greed of the investor. Many times, it is associated with "get rich quick" schemes. On this site, I would never advocate such an irresponsible way of trading. In order to be successful in options trading, you need to have a clear trading plan for the strategy that you are using, and stick with the trading rules, no matter what. Because some (not all) strategies carry the risk of a 100% loss on a given trade, the rules need to be quite a lot tighter than with stock trading - the field does not allow much space for careless mistakes! If you are going to do this, do it well and do it responsibly, for the sake of your family and your future. DO NOT get started with buying calls and puts - let this wait until you have some experience. Although this strategy can give spectacular gains, the losses are just as spectacular. I would suggest that you start with selling credit spreads. As your portfolio grows, trade some naked puts. If you have some stock holdings, sell covered calls in order to re-coup your costs and reduce your risk. As your experience grows, pick up a knowledge of swing trading, and try it out on DITM options. When you are completely comfortable with this, and have made some steady profits, then you can branch out with a small part of your portfolio into buying calls and puts.
  • Do you need to know about superior analysis techniques? No, not as much as with stock trading. If you are trading stocks, you need to be familiar with both fundamental and technical analysis methods. You pick a good company based on its fundamentals, and you pick a trade based on the technical indicators (of which there are many!). Options trading is much more simple: each strategy has its own limited set of technical indicators. For example, if you start selling credit spreads, the only things that you need to know is how to recognise a trend, using three indicators, and how to pick support and resistance levels. You don't need to know about P/E or Elliot waves or Fibonacci or anything like that! Even if you take on some of the higher risk strategies (which you should only do after a few years of experience), you need to be familiar with a broader suite of technical analysis techniques, but it is possible to get started with options with an simpler approach.
  • Do you need a large time commitment? Again, this depends on the strategy that you are utilising. It is possible to grow your portfolio by 10% per month with less than two hours per week. However, if day trading is your style, and you have the knowledge and commitment to follow the more intricate technical indicators, options trading can certainly suck you in and swallow your time!

Options trading does require a fairly active involvement in your profile, but the results are steady, firm growth during all types of market. One big mistake that new traders make is to start trading options as if they were day trading stocks, and they get involved in buying calls and puts. This is probably the most high risk strategy! If you are just starting, pick a simple, lower risk strategy, and build up your knowledge and experience over time (while growing your portfolio!). Also, you should paper trade your strategy before starting, so that you can develop a rigorous trading plan. Most good online brokers allow you to paper trade for as long as you like before committing real money to your portfolio. I started out buying calls and puts, and lost my whole portfolio in about three months. Stung from this experience, I started paper trading. It was almost a year before I commited real money again, but by then I had discovered credit spreads, and had developed a pretty solid trading plan.

TOP TIP: If you are completely new to options trading, the best way to learn is to practise, practise, practise.... The Iron Condor 101 Trading Simulator is a fantastic way to do this. You make repeated trades using historical data, and learn how to manage, exit and adjust every trade until you get it right every time. The experience you gain will be equally valuable for selling both iron condors and credit spreads. Give it a try, with a full monay back guarantee.

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  • This is one of the most asked questions in recent times. What is the truth, and what should you know before getting started in options trading?