How to Make Your Fortune in Option Trading

March 31, 2010 · Posted in options trading · Comment 

If you’ve made up your mind to turn to option trading to make your fortune, then you’ll be advised to be sure and develop your own trading guide to help you in meeting your goal. One of the first issues that your trading guide should cover is the amount of available funds you have for investing.

This is cash that you can reserve for the specific aim of trading options. You must be sure that this capital isn’t cash that will cause you fiscal hardship if you turn a loss while trading options. Financial gains from option trading can be substantial if everything is done right. However in the real world everything doesn’t go according to plan all the time. Losses in trading options are not only possible but very likely, that’s why the funds used in trading options are called risk capital. A good guideline to follow for beginners is to not use over 10% of your investment capital on any one option trade. This will help keep your risks to a minimum while allowing you to have enough investment capital to realize reasonable gains on your investments.

You should always do your research and choose an investment wisely before you begin. Starting off you’ll want to seek out the options which fall within your 10% capital budget. Then you would have to decide if you want to trade the position with a “call or a put”. Obviously there are many different option trading strategies that can be implemented, credit or debit spreads, option writing, etc, but we’ll be sticking to the basics for this article. (If you do want to find out more about option trading, you can checkout my website in the bio box) After deciding if you’re going bullish or bearish on the trade, set a realistic target for how much you would want to profit from this trade. Once you have achieve your target, usually I like to set my target for straight calls and puts at 30%, sell off half of your contracts to minimize your risk. This is called “profit taking’. In layman’s terms after “profit taking” you’ve made back about 50% of your initial risk, plus leaving the rest of your contracts to “ride” till a technical exit, then you’ll have the potential for a greater monetary gain. After all, you certainly cannot make your fortune in stock option trading if you don’t make any profits!

After you’ve begun your investment strategy, you should let it have the chance to prove it to be either profitable or non profitable. A general guideline which works quite well is to set a timeframe based on your trading system for it to work. After this time you should give it a good examination to determine if it’s a winner or a loser. By breaking down what went right or wrong you’ll be able to decide your next move confidently. It goes without saying that when you do your evaluations, you must keep good records of all transactions, with all the details included.

One of the best reasons to create your own option trading guide is that it’s tailored specifically to your own needs. You can make it as flexible or as rigid as you would like for it to be, according to your investment style. If you would like to ensure that you have a plan which does a fairly good job of capital risk reduction, then you will definitely want to go with a flexible plan.

If you would like to gather a few example strategies for option trading, you can find several websites which have strategies and tips to help you along in your quest to make a fortune in option trading. Read what others have to offer then develop a strategy which is your own, and you will be a more confident and wiser investor.

Author: Brian Lee
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Getting Started with Options Trading

March 28, 2010 · Posted in options trading · Comment 

If you are just getting started with options trading, you may feel a bit overwhelmed, since there is a wealth of available options and a multitude of ways to trade these same options. However, if you are determined, you can implement options trading as a successful investment strategy. You only need to realize what your ultimate goal is and what you hope to accomplish.

Since options trading can take on multiple roles in an investment portfolio, it is imperative that you have clear aim and focus before employing this particular method of investing. For example, your goal may be to protect your investment portfolio if the market takes a turn for the worst, or perhaps you have decided that you would like more income from your stocks. Whatever your goal or strategy is, it is essential to have one.

The next step, after deciding what you hope to achieve with options trading, is to begin learning about different options trading strategies so that you can implement a strategy or combination of strategies that will prove effective for your investment goals. There are a many strategies available for trading options, but the ones you implement will depend on what you hope to achieve.

After you have done your research, you are almost ready to begin trading options. Now you will need to choose a brokerage firm. The brokerage firm you choose will depend on the level of personalized service that you will require. If you are not yet quite comfortable with investing, you will do best to choose a firm that will guide you along as you master options trading. If you are pretty comfortable with your knowledge level, then you may choose to go with a discounted firm that does not offer the same level of personalization as the more expensive firms.

Before you begin trading options, you will be required by your brokerage firm to fill out and submit an options trading agreement. This form is used by the firm to ascertain your knowledge of options trading as well as your overall investment knowledge.

Your firm will approve you for a certain level of options trading based on the information you provide on the options trading agreement form. So if you are just getting started, it is probably safe to say that you will not be approved for certain strategies at first. This is because some of the strategies associated with options trading are pretty risky for an unknowledgeable person, and the firm uses this as sort of a built in protection feature, for both the client and itself.

Trading stock options can be a rewarding experience, both mentally and financially. However, in order to gain the most from your options trading experience, you must be diligent about your research and willing to continually expand your trading knowledge.

Author: Daniel Beatty
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13 Steps For Profitable Call Option Trading

March 25, 2010 · Posted in options trading · Comment 

Many traders like to use more sophisticated options strategies in their trading but many times the simple call options trade is the most suitable trade for the market condition. Follow the steps below to increase your probability to profit from call option trading.

1. Determine that the price of the underlying instrument is going up. Trading call option is a directional strategy. This means you have to pick the direction of the market, and in order to profit the market should move up. There are many different ways to anticipate upward market movement. Some people respond to good market news and some use fundamental data such as increasing earnings per share, increasing dividend yield, increasing revenue, etc. Some use chart patterns that indicate upward market movement such as double bottom, reverse head and shoulder, ascending triangle, and upside price breakout. Some use other systems such as Elliot waves, and systems which use combinations of price patterns and other indicators.

2. Determine the target of the price movement. The system that you use to indicate an upward price movement should also indicate a target price for the movement.

3. Anticipate the time for the underlying price to move to your target price. How long do you expect the underlying instruments price to move to the target price? This is important to determine the expiration of the call options you want to trade.

4. Look at options chain. Bring out the options chains to see the quotes and other relevant data. Nowadays, real time options chains are easily available through the internet. You can also call your broker to get this information.

5. Narrow down to the exchange, and expiration date. If you trade online, determine the exchange you want your order to be submitted. Determine the appropriate expiration date based on the time you expect the price to move. Unless you are using a trading system which trades options near their expiration, usually you would want to buy call options with expiration that is slightly longer than the anticipated time. This is to reduce the effect of time decay. This is very important because time decay can cause your call options to lose in value.

6. Compare the Delta, Gamma, Vega and Theta for several strike prices of the same expiration. After you narrowed down your options chain to the specific exchange and specific expiration date, you look at the Greeks. Ideally you want to have high Delta, high Gamma, low Vega and low Theta. High Delta and high Gamma can give you a higher and faster profit when the underlying instrument’s price moves up. When you are buying options, low Vega is very important. Low Vega means cheaper options and when Vega increases, you make profits even if the underlying price does not move. Low Vega is associated with low volatility and quiet market. And low Theta means the call option makes smaller loses due to time decay. If you are a longer term trader, you can choose out-of-the-money call options. These options have smaller delta but they are cheaper. If you are a shorter term trader, you would prefer at-the-money or in-the-money call options because they can give you faster and higher profits due to higher Delta and Gamma.

7. Evaluate your risk versus rewards based on your target price. You can also use a risk profile to help you make the evaluation. Calculate you breakeven point using this formula: breakeven = call strike + call premium

8. Look at the open interest and volume. It is better to trade in an active market so that you can buy and sell easily. Another reason is that you don’t lose a lot on the bid/ask spread.

9. Choose the best call option with the highest probability for profits.

10. Determine exit point and stop loss. Make sure you have your profit taking points and stop loss point in place before you place in your trade. Do this so that your emotions do not take over your decision making after you place in your trade.

11. Place in your trade. Call your broker or key in your trade online.

12. Watch the underlying instrument’s price movement and the option’s price reaction

13. Close your position. If you made a profit, close your position by either selling the call options that you bought or exercise the call option and sell the shares. If there is some time remaining before expiration, normally it is better to sell the call options because there is still time value in it. If you made a loss, close your position by selling the call options.

Author: Wai Hoong Chin
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Just What is Currency Option Trading

March 22, 2010 · Posted in options trading · Comment 

Some people, when they hear about the currency market, they only think about the foreign exchange market. Rarely do you hear about the other side of currency trading which is known to some people as currency options trading.

Currency options trading involve selling and buying the rights to buy and sell a certain fixed amount of a currency at a given amount of time.

The very basic premise of currency options trading is that you can have the prerogative to trade this much amount at whatever cost it has during the time.

This means that you can make, or lose money much faster this way.

The currency option trading market is the only 24-hour option trading market in existence. This is due to the 24-hour operation of the foreign currency market.

Currency option trading also reflects the erratic nature of the foreign exchange market. In buying or selling currency options, you have the potential to make a lot or lose a lot of money pretty quickly.

Currency options’ trading is like betting on the future. If you pay this much money for the right to sell this much cash, how much will you be able to make?

However, currency option trading is more stable than foreign currency trading and is often used by corporations as a way to hedge against the effects of fluctuating exchange rates.

Currency option trading involves anticipating the different risks a long time before they actually happen. Unlike in the foreign currency market where things can change in a matter of minutes and therefore, decisions are done quickly, currency option trading involves a specific date when you expect the value of the option or the currency to change.

Another good thing about currency option trading is that it is so versatile. You can adjust your financial position long before an event happens to affect it.

In a way, currency option trading is like a safety line when you feel doubts about a decision you made regarding your money and the foreign currency exchange market.

In currency option trading, what’s important is insight. You need to be able to look at the long-term implications of events and factors instead of thinking about the short-term effects.

Thus is due to the fact that, in dealing with currency option trading, you are dealing with future long-term happenings.

Remember that the value of a currency can change many times before you need to exercise your currency option, so you need to be very observant and wait for the right moment before you cash in your chips.

You also need some pretty good contacts if you intend to deal in currency option trading. You need to be able to get the right information on what would truly affect your money. A revolution, for example, can be devastating on the currency of a country- but only for a short while. If the new leadership of that country causes it to become more progressive, then the value of that currency would increase even more than it decreases.

This means that you have to learn how to look at the big picture if you expect to make a lot of money on currency option trading.

There you go. Those are just a few things you may want to know about currency option trading. You have to remember that it’s a whole different ballgame than FOREX trading.

Author: Chet Holcomb
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Explosive Stock Option Trading System Using Google, CME, or RTP during Expiration Week

March 19, 2010 · Posted in options trading · Comment 

Successful traders learn to follow a set of rules consistently. These set of rules are called a trading system. When using stock options, it is very important to use a stock option trading system. Traders really need to backtest several stock option trading systems and avoid commonly taught systems that result in a net loss over time. A ‘fun’ stock option trading system involves high flying stocks Google, CME, or RTP. I call this a ‘fun’ system because you should only trade with money you can lose. In this system, you should really trade no more than three contracts. The system is for illustration purposes. Remember – options involves risks – including losing your whole account if you do not manage your risk and size you positions properly.

The leverage of stock options can cut both ways. You can lose faster as well as win faster with stock options. Therefore, you want to get past the point of trading because of emotions or addiction and trade by your rules. Of course, your stock option trading system needs to be backtested with lots of samples to ensure you have positive expectancy.

Positive expectancy means that when you trade many times over the long run, you will have a net profit. You will be surprised that some stock option trading systems being taught or sold may have a NEGATIVE expectancy in the long run. That is, you will be trading at a net loss. They may have worked in a strong trending market a few years ago but they do not work in our current 2005-2006 stock market.

One way to see explosive results is to focus on stocks that are expensive and that have a high intra-day range – or average true range. Google, CME, and RTP are in the $200 to $500 range. In fact, there are not many other stocks over $200 that have options besides those three. Normally, options two strikes out of the money are relatively expensive for these stocks – except during the expiration week. Remember, options basically trade on the stock price difference, whereas stocks trade on the total stock value. A $200 stock with a 5% intra-day range has a ‘difference’ value of $10. That $10, in absolute terms, can cause some wild swings in option prices during a certain time of the month.

Let’s look at a stock option trading system that tries to take advantage of expensive stocks fluctuating during the time of the month when options are the cheapest:

1. On the Monday before option expiration, buy three strangles on Google, CME, or RTP that are 2 strikes out of the money for that expiration. For example, on Monday, May 15th, with expiration Friday on May 19th, Google is at 400. Buy the 420 call and the 380 put. If it is not earnings month, the strangle should cost around $300 to $350.

2. You’ll have to watch the price quote most of the day for Tuesday, Wednesday, Thursday, and even Friday

3. Try to estimate based on chart patterns whether a certain time is close to the high or low for the day. Better than that, if the price of the total strangle is profitable by $60 or more per strangle, sell one. That’s a 20% profit. The normal intra-day range for these three stocks swings enough to cause some profit.

4. Repeat step 3 on Wednesday and Thursday. Many times a year, there is a news event that can cause a $10 to $30 move on a single day. These are the home runs you are looking for that can more than cancel the strike outs of the relatively inactive days.

This stock option trading system has precise definitions for entry and relatively precise definitions for exit. Trade like a robot one week a month. In future articles the detailed backtesting results of this system may be presented.

Steve Burke
http://www.breakthroughbacktesting.com

Author: Steven Burke
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Simple Basics of Stock Options Trading – Trading with the Trends

March 13, 2010 · Posted in options trading · Comment 

IPOs are the simple basics of stock options trading and a part of the market that always generates a great deal of interest, along with stories of fabulous profits and spectacular losses. But, there are a ways to reliably profit on IPOs. Look for the trends that they cause and trade with them.

IPO spinoffs are a solid basics of stock options trading trends to work with. A company that’s going to spin off a part of itself as an IPO tends to move steadily up in price until the IPO date, starting a week or two before that date. On the day the IPO starts to trade, the parent company`s stock options typically dips sharply. The best strategy is to buy the parent once it starts moving in anticipation of the spinoff, sell it the day before the IPO is to begin trading, and then short the parent just after the IPO starts to trade.

Another basics of stock options trading trend to consider is the `quiet period` trend. The `quiet period` for IPOs is the twenty-five days after a company goes public. During this time, the SEC forbids the company and the IPO`s underwriters to say anything that isn`t covered in the company`s prospectus or final registration statement. The underwriters face further restrictions on issuing any research.

Another basics of stock options trading tip is that as stocks near the ends of their quiet periods, they tend to steadily rise in price in anticipation of the `strong buy` recommendations most will receive from their underwriters after the quiet period ends. The run-up usually begins about ten days prior to the quiet period expiration, and is often accompanied by steadily increasing volume. It`s wise to sell quiet period stocks the day before the recommendations come out. Why not hold the stock options after it gets a `strong buy` recommendation? It`s another case of buy the rumor, sell the news. It`s also best to trade this trend with stocks that have highly respected underwriters and are in hot sectors.

Another basics of stock options trading play is to short stocks with upcoming IPO lockup expirations. An IPO lockup is a period of time, usually from six to eighteen months, when insiders who obtained the IPO at the offering price or less cannot sell their shares. Once this time period has elapsed, insiders often sell their shares. This trend is shortable because the greater the number of shares unlocked, the more likely it is that insiders will start to sell their shares, particularly if the market is not doing well but the share price is still higher than the IPO offering price. And the more shares freed, the better the chance of a negative effect on the share price. This trade works best when the number of shares being unlocked is more than 25% of the current market capitalization.

You should short the stock options roughly ten days before the IPO lockup expiration date, since anticipation of the event usually scares traders out of the stock options well before its actual date. Cover the short about five days after the expiration date. By that time, most insiders will seem to have sold, and the news will be priced into the stock options.

Like any other trade, these basics of stock options trading tips are not foolproof. Often one of the underwriters will upgrade the stock options as the lockup expiration approaches, or the company will release news to boost the stock options price to counter-act the selling. Be sure to check company news closely, since if the market is bad and share prices are down, lockup periods may be extended.

But when the IPO market is hot, a lot of traders buy into any new company. They commit a trading mistake that`s like placing an overnight market order: They place market orders for an IPO before it starts trading on its first day, which leads to outrageous run-ups in price right when trading opens. For the trader, these orders are a sure way to lose money. Your order will end up being filled at a ridiculously high price that the stock options may never see again.

If you`re going to try to trade an IPO on its first day, don`t place a pre opening market order. Don`t use market orders at all. The way to buy is with a limit order after the stock`s price has pulled back a bit and is about to bounce and continue upward again. The goal is to buy at the bottom of the bounce, hold it as the price rises, and sell just as the price is about to fall again. You may be able to do this several times, until the stock`s momentum drops. Remember, you can`t short an IPO during its first thirty days on the market.

If you want to hold the IPO past its first day, it`s hard to know exactly when to jump in, but wait until after the initial volatility has ended. The higher the IPO has opened the less chance it has of continuing to climb throughout the rest of the day. If the IPO has opened at an extremely high price, it will probably sink to a fairly stable level in an hour or two. If not, and you think the price could go higher, you might want to buy fairly soon after the initial volatility has ended. One option is to buy half your shares and then wait to see whether there`s a slump in the price later in the afternoon when you can buy the rest for less. IPOs can be incredibly volatile, and like with any other trade, setting stops is critical. But, traded carefully, these basics of stock options trading tips are a consistent way to create trading profits.

Author: David Jenyns
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How People Lose Their Shirts in Options Trading

March 10, 2010 · Posted in options trading · Comment 

You must have heard horror stories surrounding options trading before. Stories such as how some people lose their whole account within a few days and even stories of options traders going bankrupt in express time.

These stories have no doubt cast a shadow over options trading and there are even people who now tout that options trading is as risky as futures trading.

Well, strange thing is, after more than 15 years of trading options, I have never experienced losing all my money within a few days nor going bankrupt. This led me to wonder why these things happen to some options traders. After some investigation, I conclude that it is not options trading that breaks accounts but specific things some options traders tend to do, especially beginners, that opens the door to such financial disasters. I narrowed these reasons down to two main ones.

The first of these is that some options traders trade options just like they trade stocks; buying call options with their whole account on that one “hot stock.”

Yes, this is the number reason why most options beginners lose their shirt. Most beginners to options trading do with call options exactly what they do with stocks when they have a “hot tip”; throwing their whole account into that single “hot” trade. Now, this isn’t that big a problem in stock trading because if the stock didn’t move as expected, the trader could simply continue to hold the position until it does, sometimes for years. However, when you buy call options on stocks that didn’t eventually move up as expected, the call options can expire worthless by expiration, taking your WHOLE account with it if you bought those call options with all the money you had! This problem is made even more pronounced by the fact that options have a definite expiration date that goes from a few months to a year for some stocks but never forever. This means that you do not have the luxury of holding on to bad trades forever, hoping they will come back in a few years time.

Professional options traders like me only enter a single position with money we can afford to lose. If I intend to lose no more than 10% of my account on any one trade, I do not use more than 10% of my account in a single trade. That’s right, you NEVER buy a single options position or options contract with all the money you have! Although that would have made sense in stock trading, it is pure suicide and gamble in options trading.

The other reason is trading credit spreads or naked option writing without using stop loss.

Many options beginners were taken in by the apparent “free money” phenomena of writing naked options positions unaware that most of these credit strategies have unlimited loss potential.

For instance, if you wrote call options (shorting call options), you would make a fixed premium in profit if the stock went downwards or sideways. Some “gurus” call this “playing bookmaker”. Well, they are right that you are playing bookmaker to gamblers by selling options to them but they forgot to mention the fact that sometimes, gamblers win big too. When you write call options, your position will make an incrementally bigger loss as the stock price rises! It will continue to make bigger and bigger loss as long as the stock continues to rise. This is what is known as an unlimited loss position. This loss is often, or always, much bigger than the premium you received from selling the options. Before you know it, your entire account is wiped out on this one trade because the stock refused to go down as you expected it to.

Does that mean we should not trade credit spreads or naked writes ever again? Not really. These are excellent options strategies but only if you trade them using a specific and definite stop loss point.

Yes, most options trading beginners trade such unlimited loss potential credit spreads with stop loss points but most of them give in to emotion when it’s time to stop loss and hold their positions beyond their stop loss points in hope that things will turn around, which most often, they never do.

Professional options traders always trade unlimited loss potential positions with an AUTOMATED stop loss point. That’s right, automated stop loss that works without human involvement. This can be in the form of a stop limit, contingent order or trailing stop loss order. As long as you do not have to physically execute the stop loss. Physically executed stop losses are stop losses that rarely gets executed. Remember that.

Buying options with your whole account and trading unlimited loss potential options positions without stop loss points are the two main reasons most options beginners lose their shirt. Take heed of my advice here and you would go through your initial options trading years in much more safety.

Author: Jason Ng
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How to Learn Options Trading

March 7, 2010 · Posted in options trading · Comment 

Most people think they can learn options trading the very same way they learnt stock trading, which is just buying an options on stocks they think will do well. It’s just that simple isn’t it? Well, the simplicity ends when they discover that there are not one kind of option but two and each kind of option has countless strike prices and expiration dates! That’s right! They suddenly realize that there is much much more to options trading than stock trading.

Yes, stock options are a totally different ball game from stock trading even through they are used for the very same purpose of profiting from moves that stocks make. Yes, the fact that you are presented with so many different strike prices and expiration dates instantly tells you that there is no way to just pick on and profit. Much less trying to learn by trial and error. Yes, trial and error is very expensive in options trading as you cannot hold on to a mistake like in stock trading forever hoping for a come back. Options expire so options don’t give you the ability to hold on to your mistakes forever.

So, what is the correct way to learn?

To learn how to trade options, you need to first of all learn what call options and put options are. All optionable stocks come with both call options and put options. Call options allow you to buy a stock at a fixed price no matter what price the stock is and put options allow you to sell a stock at a fixed price no matter what price the stock is. This means that if you buy a call option and the price of the stock goes up, the call option would make a profit because you still have the right to buy at a price lower than the stock price. As such, you would buy call options when you think a stock is going to go up. Conversely, put options allow you to sell a stock at a fixed price. This means that if you buy a put option and the price of the stock goes down, the put option would make a profit because you still have the right to sell at a price higher than the stock price. As such, you would buy put options when you think a stock is going to go down.

This is only a brief outline of what call and put options are, obviously there is much more to it but this is where you start learning about options.

After you have a clear idea what call options and put options are, you need to know what strike prices and expiration dates are. A strike price is the price agreed upon in an options contract. A call option with a strike price of $10 allows you to buy a stock at $10 no matter what price the stock is and a put option with a strike price of $10 allows you to sell a stock at $10 no matter what price the stock is. There are strike prices covering a very wide price range both higher and lower than the prevailing stock price. Which brings us to the next important thing to learn about options; Options Moneyness.

Depending on the strike price in relation to the prevailing stock price, an option can be either In The Money, At The Money or Out Of The Money. Options of different moneyness caters to different outlooks. You would buy out of the money options when you think a stock is going to make a big move and you would buy in the money options when you expect only a relatively small move. So, unlike stock trading where you simply buy the stock when you think it will go up, options trading make you think one more step deeper into the possible degree of move in order to maximize profits.

Complete understanding of options moneyness and the implications of options of different moneyness is impossible without an understanding of how options are priced in terms of their intrinsic value and extrinsic value. Only by understanding the difference between intrinsic value and extrinsic value and how to calculate how much of each value is in the price of an option, you cannot intelligently choose the right option for your specific outlook.

Once you have a good understanding of what call and put options are, how they are priced and the implications of different moneyness, it is time you learn how to place options orders through your options broker. Placing options orders is another complex issue as there are 4 main order types for options trading unlike the two simple order type for stock trading. Buy to open allows you to open a new options position by buying it, sell to open allows you to open a new options position by creating a new options contract and selling it, buy to close allows you to buy back and close options you previously created and sold and sell to close allows you to sell options that you previously bought. Knowing exactly what these orders do is extremely important for knowing how to execute extremely complex options strategies.

Yes, Options Strategies allow you to profit from multiple directions and cater to even more specific outlooks and is one of the most unique features of options trading. Putting different options both long and short together produces strategies that go beyond simply profiting when a stock goes up or down. There are literally hundreds, if not thousands, of options strategies and some are so complex that a single position consists of 4 to 8 different trades utilizing a complex combination of the different order types you learnt above. In fact, each option strategy is a study on its own that requires long period of learning and trading to master.

After you have learnt all of the above can you start placing some simple options trades and know exactly what you are doing. See how much learning it takes to place your first options trade? Yes, options trading require investment knowledge that goes beyond merely buying and selling and is as much a science as it is an art. Follow the above steps, do your due diligence and you will be all set for your first options trade.

Author: Jason Ng
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Options Trading – Basics of Options Trading Explained

March 4, 2010 · Posted in options trading · Comment 

Option trading gives us huge amounts of leverage. Think of a water skier behind a boat all the boat driver has to do is turn the wheel slightly and the skier is flung past the boat at a rapid pace or leveraged past the boat. So in the technical sense leveraging means using a small effort to move a large object.

Looking at it from a financial sense, leverage is having control over a much larger investment or asset, or gain a very high return using a small amount of money. From my own experience the uneducated use, or abuse of leverage can be risky. In fact, Any investment strategy carries a great risk if you don’t know what you are doing. Your “risk” when trading any Stock Market means the probability of a donation (loss) of your trading capital. A common misconception with Option Trading / Stock Options is that their use carries a very high risk. Actually Stock Trading can carry a greater risk…let me explain why.

Leverage – What you need to remember with Option Trading / Stock Options is that they allow you control over the same amount of shares using small amounts of money than you would need to buy the actual stock. Obviously this is the leverage we are talking about. However consider this… When you are Options Trading, you risk a much smaller amount of money for the same quantity of the underlying stock, so in actual fact if you were to buy the stock outright, your risk would be considerably higher!

Here’s an example…if XYZ shares (my favourite stock) was currently trading on the ASX at $30.00 and a Jan $30.00 Call Option costs $ 1.60, we could buy 1000 shares of XYZ for $30,000 or we could spend just $1,600 on the May $31.00 Call Options. By purchasing the Call Options, you would still control the profits on $ 30,000 worth of XYZ shares, but the maximum you would stand to lose is only $1,600 compared to the whole $ 30,000 if we were to buy the actual shares.

Leverage becomes dangerous when we decide to risk the whole $30,000 in Stock Options, and is one of the biggest mistakes made in Options Trading. When using the power of leverage with Stock Options Trading there are various ways to reduce your risk, depending upon which strategy you choose to use, and your discipline to follow money management rules. Short selling – There is really only one way a Stock trader can make money in a down trend, and that is to “Short Sell” a stock. This is the process of selling in advance, stocks that you do not own, with the assumption that the stock price will continue to fall. This exposes the trader to an unlimited amount of loss should the stock rally all of a sudden, resulting in margin problems.

As an Option Trader, you could simply buy put options to profit from the same drop but limit your potential losses to only the price of the put options. For example….if XYZ shares were trading on the ASX at $30.00 and a Jan $30.00 Put Option costs $ 0.80 then buying 1 contract of Put Options would expose you to a maximum loss of just $ 800 if the stock price should rise to $ 35. However if you were to short sell the same shares, your maximum potential loss, would be $ 3,000. One Direction – When you trade the stock, you either make money when the stock goes up or when it goes down (when you short sell) but NEVER in both directions at the same time. In options trading however, there are strategies that allow you to profit from BOTH up or down moves, as well as when the price trends sideways. If you can profit from any direction, then the higher your chances for profit and therefore the lower the risk. I will show you in another article the covered call strategy.

Hedging – Hedging is the practise of insuring against risk. With Stock Options you can take a position to offset the risk in another. When you trade Stocks, the only way to hedge your position against risk is to manage and diversify your portfolio. When trading Stock Options, you can not only manage and diversify your portfolio, you can also hedge options with options to minimize your potential losses, and even hedge, or insure stocks with options!

Stock options are a far more advanced financial instrument than stocks themselves, and they can allow you to profit regardless of market direction or conditions. But just as you face a potentially high risk if you drive a car without a safety/seat belt, if you don’t obey the rules when using leverage and trading Stock Options you expose yourself to the same possibilities. However, when leverage is respected and used properly, Options Trading can be safer than Stock Trading.

Author: Anthony J Manly
Article Source: EzineArticles.com
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10 Options Trading Tips For Conservative Traders

March 1, 2010 · Posted in options trading · Comment 

There are many ways to trade options. In fact, there are unlimited ways to trade options due to the unlimited number of options strategies and approaches that can be adopted. This article outlines 10 options trading tips that conservative traders can follow for maximum safety in options trading.

1. Use only money you can afford to lose

This is the most common advise given in options trading and one which most people choose to ignore to their own detriment. Using only money you can afford to lose means that if you hope to lose no more than $200 in a single trade, then you should use no more than $200 in buying options at any one time. The good thing about options is that the leverage it offers allows you to make a significant profit even with very small capital outlays and even if you get it wrong, all you can lose is $200, nothing more… if you follow the next tip.

2. Use only debit strategies

A lot of options beginners start out options trading using complex credit strategies. There are 2 drawbacks to this approach. Firstly, the complexity of some credit spreads caused beginners who are not used to placing options orders in the first place to enter the wrong orders or leg in the wrong way, resulting in instant losses. Secondly, credit spreads require significant margin which may not allow beginners practicing with a small account to use them in the first place. Using debit strategies allow you to control your losses as well. What you invest is all you can lose, period. You won’t lose more than you expect unlike some unlimited loss credit strategies.

3. Always virtual trade new options strategies

This tip translates to never using real money for options strategies which you have never used before. Always practice new options strategies on the virtual trading platform offered by your broker. If your broker does not even have features like this, its time to consider changing brokers, which brings us to the next tip.

4. Choose the right broker

I would say the right broker should fulfill all of the following criteria; 1, discount commission. 2, offers free real time quotes. 3, offers virtual trading practice platform. 4, offer advanced orders such as contingent orders and trailing stop loss. 5, offers both stock and options trading. Definitely no call in brokers! In options trading, you want to be in control of your own trade and be able to execute them at the click of a mouse without the frustration and delay of calling a broker who may not even understand what you want executed in the first place.

5. Always buy options or positions with at least 3 months to expiration

Unless you are a sniper sharp stock picker or using credit strategies which you want expire quickly, always buy options or position with at least 3 months to expiration. There is nothing more frustrating to see your positions expire before the stock starts to move.

6. Take advantage of low commissions to close out on expiration day

Most options brokers offer an exceptionally deep discount for closing out options positions on the expiration day of those options. Take advantage of this deep discount to close out positions that are at the money or very near the money instead of risking an accidental automatic exercise.

7. Use advanced orders to enforce your stop loss

Most people give in to their emotions when it’s time to take a loss thinking that the position might come back the next day. We all know what usually happens after that, yes, the position gets held all the way to expiration and then it expires worthless, losing 100% of its value. Yes, nothing is more difficult than trusting your human emotions to enforce stop loss points. That is why you must always make use of advanced orders such as conditional / contingent orders or trailing stop loss to automate your stop loss policy.

8. Trade for profit, not for fun

Most beginners trade options for fun more than profits. Their main aim is merely to use these overly hyped options strategies and see how they work with the aim of making money being secondary. Yes, treating options trading like a hobby and options trading will behave just like a hobby and hobbies cost money. If you don’t think a trade has a high chance of turning out successfully, don’t make it.

9. Use put options to hedge your stock holdings

Perhaps the best use of put options of all time is to buy them as a hedge against your stocks. If you have stocks which you are holding for long term investment purpose, consider buying LEAPS put options expiring six months to a year out as protection against catastrophic drops.

10. Avoid Out Of The Money Options if you intend to trade with all your money

The reasons why most beginners lose all their money in options trading in one go is because they buy out of the money options with all their money. This means that they will lose all their money even if the stock moved in their favor but not enough to bring the options in the money! Now, bearing in mind that you should only be using money you can afford to lose, buying only in the money options with those money give you even higher protection and lesser chance of losing everything.

Author: Jason Ng
Article Source: EzineArticles.com
Provided by: Programmable Pressure Cooker

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