Many aspiring traders want to know how to trade options.
“So… you want to know how to trade options?”
That and a deep sigh is the usual response I end up giving when asked about options trading.
Options are complex. They can carry extreme risk. It’s for these reasons I often approach the subject with caution.
My reluctance towards the subject is not for a lack of legitimate strategies. There are lots of legitimate and profitable methods for trading options.
However, the right attitude and understanding of the fundamentals can lead to success. And options trading can be quite rewarding using the proper approach.
Since options are popular and here to stay, I’ll drop the reluctance. I want you to have the best start possible in this challenging market. Here are my seven steps to getting started the best way possible.
How To Trade Options – Step #1:
Brokers are an important part of trading. They hold the keys to you accessing the market. Brokers also control how much commission you have to pay for the privilege of trading.
SERIOUS TRADERS CARE ABOUT 3 ASPECTS OF A BROKER:
- Execution Speed
- Platform, and
Electronic trading has done away with the larger differences in execution speed quality. But there is one thing that has not changed over time. Commissions matter more for options trading than for stocks. This is because the value of the options traded is usually lower than it is for stocks.
Consider the impact of paying $10 in commission to trade 100 stocks worth $50. That’s $5,000 worth of stocks that you pay $10 in commission to trade. The commissions represent 0.2% of the trade value.
Now consider an option on that stock. 100 options costing $3 is a total trade value of $300. If it costs the same $10 in commission to trade the options, the commissions represent 3.3% of the trade value.
I conduct most of my trading through Interactive Brokers. You can see my detailed review of their services here. Interactive Broker’s execution is excellent and their commission structure is fantastic.
Then there’s the decision around options trading platforms. I like TD Ameritrade’s ThinkOrSwim (TOS) platform. The way they have designed the interface for options analysis is admirable. If you are serious about trading options, you’ll definitely want to check the TOS platform out.
How To Trade Options – Step #2:
How much money to start trading options with is a difficult decision to make. This is true whether you are looking to excel in stocks, options or any other trading category.
One consideration is stock options are subject to the same Pattern Day Trader rule as stocks. That means you need at least $25,000 in your account to day trade options.
The Pattern Day Trader $25,000 account minimum rule affects options too.Click To Tweet
Note: If you’re looking for some ways to avoid the Pattern Day Trader Rule, check out this article.
Yet there are even more important constraints than the Pattern Day Trader rule. Constraints such as how much risk capital you have available are paramount. This is an amount only you can know for your own situation.
It is important to remember the amplified volatility and risk of options. This means the money that you pledge to trade options should be 100% risk capital. And in laymen’s terms that means you have to be willing to lose it all.
How To Trade Options – Step #3:
There are so many choices when trying to pick what options to trade. That said, there are particular things to look for that will serve you well and narrow your search.
THE MAIN CHARACTERISTICS TO SEEK INCLUDE:
- Liquidity (the higher the better)
- A tight spread, and
- Having a strike price close to the stock price
Options trading can be challenging. Ensure that the options you are trading have the characteristics listed above. It’s an important first step that makes things easier.
How To Trade Options – Step #4:
Options have many facets that make them different from trading other products. Those other products include stocks, futures, and Forex.
Besides having to get the direction correct in a trade, an options trader has to be correct on other aspects too. Timing and volatility considerations, among other metrics, have to align for success.
Greek letters represent those variables.
The most significant of the options Greeks are:
- vega, and
An options trader is operating blind if he does not have a firm handle on those variables.An options trader must understand the Greeks.Click To Tweet
I once heard an option trader’s lament. It summed up the distress created by trading options without understanding the Greeks:
“I have never lost so much money being correct.”
Don’t let this be you. Respect the Greeks. Learn them well and they will serve you well.
How To Trade Options – Step #5:
I have written here that options strategies can get quite complex. Some positions can combine four simultaneous buys and sells of different options contracts.
Trading these exotic combination strategies incurs greater commissions. They also can tie up a lot of trading capital.
Start off simple. This is the advice that I offer to traders no matter what they are trading. It’s no different with options.
Forget trying to deploy a complex options strategy without former trading success. It is tantamount to attempting to bake a delicate French soufflé having never so much as made a sandwich.
Succeed in options trading by starting off simple. There is plenty of time to complicate things later. Go with simple, non-complex options order types until you have proven success.
How To Trade Options – Step #6:
Options are attractive to many. And the attraction comes from large potential returns achievable with little starting capital. But this attractive advantage has risks.
Leverage and fast movement in financial products are akin to a fast car. If you already know how to drive very well, the fast car may be a complement to your existing skills. But if you’re a new driver, that fast car can be your biggest danger.Trading is trading, no matter what market you prefer.Click To Tweet
The same goes for options. They can be helpful for traders with success in lower volatility markets such as stocks.
Trading is trading. There is a case to for keeping things simple when starting out. It’s a good idea to start with a market like stocks.
Grow your skills before moving to the more complicated world of options trading.
How To Trade Options – Step #7:
The key to a successful start and ongoing success in options is to keep learning as much as possible. One resource that focuses on options trading is Tasty Trade. It’s a great place to learn.
Tom Sosnoff (who runs the company) and his team do a fantastic job. They teach and reinforce solid strategies. And they’re pretty entertaining at the same time.
In addition to the basics, Tasty Trade also their in-house research team. They are always sharing new findings and offering easy to understand explanations.
What makes the content so special is the nature of research. It is labor-intensive research that uncovers the validity of option trading strategies.
Tasty Trade content is good for both active traders and academics alike. If you’re serious about trading options, make sure you check them out.
Options trading can be engaging as well as profitable. It’s important to understand this before you start out. There are many complexities unique to trading options.
These complexities are the very reason why options are not my number 1 pick. That sentiment is double for people who recently started learning about trading.
As an experienced trader (including several years in options ), I will share this…
I find the benefits of trading options often do not justify the costs, risks, and limitations.
Success is attainable with options trading. Yet it is offset by a much steeper learning curve than other types of trading. It reminds me of this saying.
“Just because you can, it doesn’t mean you should.”
As with all trading, the best trade that you can make is investing in your own knowledge. Learn all you can before you jump into this rewarding yet dangerous area of trading.
For more day trading techniques, tools & strategies, check out these articles:
- How To Trade Online Stocks: 5 PDT Rule Tips
- #1 Way To Practice Trading Options
- Biggest Dangers When You Trade Stock Options
Take these seven steps when starting out in options trading. Learning how to trade options properly from the start ensures you get going the right way.
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