A How-To For Beginners In Options Trading

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A How-To For Beginners In Options Trading
By Ron Ianieri

Here are 10 steps that you — and/or your clients — need to take before taking the plunge into the options markets.

1. Get educated. Acquire an options theory education, especially about the “Greeks,” and become well versed in core options strategies. Without this knowledge, you really shouldn’t be actively involved in the options markets.

Options are great tool, but they are a not a straight-up proposition like stocks or exchange traded funds. There are complexities to options that are not readily apparent.

Not fully understanding how options work and how to assess the risk that a position might entail puts a trader at a disadvantage, to say the least.

Knowing a few options strategies is really only the beginning.

2. Start slowly and trade to your comfort level with each strategy. A good way to get started is to build on a solid options theory education, one strategy at a time.

Initiating various strategies on a basket of underlying investments will lead to some sort of a portfolio.

Without having considered the portfolio and the strategies fully before acting on them, a trader will more than likely end up with a far less than optimal situation; in fact, parts of the portfolio may only be adding risk, with virtually no chance of higher return.

So while it’s generally better to diversify, it’s much better to do this methodically than on an ad hoc basis.

3. Acquire a basic knowledge of charting. Although it may frustrate the die-hard fundamentalists and random-walk theorists among us, charting plays a significant role in today’s markets.

Chart theory and application are cited increasingly in publications and other forms of media.

Published studies suggest that even modest technical-analysis tools can enhance returns greatly over time.

Knowing even just a few key concepts can at the very least assist traders/investors in avoiding dangerous situations that are better left alone.

4. Get a broker who understands options, provides good options support and supplies a set of tools to monitor and assess risk. There really can’t be a substitute for this requirement. If just starting to delve into the options markets, the last thing that a client needs is a broker who’s really not experienced enough or equipped well enough to assist them.

After all, that’s what the commissions that they are charging should cover.

The markets at times can present rare situations that will make even a seasoned pro options trader hesitate.

At those times, an adviser really will need to be there for their client to guide them through the trials that the market may bring.

At this point in time, there’s no excuse for not providing some basic options-risk-assessment tools for clients.

Options volume growth has been impressive over the last decade.

A sure sign of an inferior broker is one who cannot provide adequate tools to assist their client’s trading and position management.

5. Always know the risks of the trade and any possible news events that could affect your stock and options price — e.g., earnings, dividends or announcements. The markets at times can be very unforgiving. In fact, with so many unforeseen events occurring in the markets, traders sometimes can do everything right and still lose.

However, there’s no substitute for preparedness.

The markets do not think of themselves as domains for people’s hobbies. They are usually heart attack serious, especially to most traders when their own capital is on the line.

Traders have to understand fully as much about their risks as they possibly can at any given time.

Staying apprised of the news and keeping an eye toward known future events or dates is the minimum requirement.

It’s better to have a beat on the sector or at least the macro market picture in general.

While “pure” chartists may eschew any and all knowledge beyond the chart, events tend to happen in real time, requiring traders to think on their feet.

6. Develop or locate tools to help better rank and evaluate tradable opportunities. The options trading arena is a vast one that’s ripe with opportunity.

While options can be of value to a trader who likes to look at 20 or so stocks, they are undoubtedly of greater value to a trader who has refined their approach with technology to screen the more than 2,000 instruments available in the U.S. markets alone.

Many directional traders eventually transition into the options markets for superior risk management and leverage, etc.

Most need only modify their approach to synergize with options strategies. That’s an ideal way to go, because they maintain their familiarity — and thus their level of comfort — while entering into unfamiliar markets.

Others who are new to both options and directional trading may be advised to explore several websites that cater to the options-

trading community.

Becoming familiar with tools that help to rank and evaluate potential trades is a great way to learn and improve, as it expands the trader’s scope of opportunities.

7. Consider subscribing to some type of mentoring program; research mentoring providers. Do you think the stock market can move fast at times? The options markets can move at warp speed. The leverage of options can really accelerate matters.

This can lead to bewilderment for those who have entered the markets without fully appreciating the risks involved.

In fact, many professional floor traders at times have been known to leave the floor in a daze. One way to avoid this scenario early on is to become involved in a mentoring program.

While not inexpensive, this type of program is usually much less expensive than the “market tuition” that many new traders find themselves paying at some point (usually much sooner than they expect).

The truth — and most professional traders will tell you this — is that if they hadn’t had a strong mentor at the start of their careers, most veteran traders wouldn’t have lasted a year.

Guidance from a true guide can be practically priceless in the end.

8. Always analyze your future price and volatility movement, and the effect of time, to understand the inherent risk of your possible and current trades. This is where a good risk management system is essential.

Being able to “walk forward” in terms of time and options volatility levels is a feature found on most risk systems.

This really allows traders to anticipate profitability and risk in advance and thus prepare themselves to lock in profits, limit losses and mitigate risks, or to roll into other strategies, etc.

This is also one of the best ways to learn not only how options really work but to have it sink in to a second-nature level.

Once a trader has reached that point, their confidence really begins to lift, and their trading results rise in tandem.

9. Always evaluate where you are in the implied-volatility range. While there are many components that affect options prices, it’s a rarity when any are more important than volatility.

It’s an absolute must to know where the current implied volatility of an option is in relation to its preceding range. This is a volatility stochastic, if you will.

Not understanding this has left many a new options trader baffled when they’ve gotten their anticipated move from an underlying, only to lose money on the trade.

Not knowing what volatility is and how it works is unacceptable. It’s critical to have volatility working for you, and not in opposition.

A solid options theory education and a mentoring program will ensure a new trader of knowing the ins and outs of volatility.

A rudimentary understanding of the math involved or definition of volatility is not enough.

Unfortunately, most new traders tend to learn this fairly late in the game.

10. Do a volume/liquidity analysis. Always try to initiate positions in products that have liquidity.

It is more difficult to extract profits — or neutralize risk — from options with low volume or poor liquidity.

The bid-ask spread can be much more cost prohibitive than the equity itself if it’s a low-options-volume equity.

Trading against a specialist or small “crowd” that knows your specific trade from memory will not help you when it’s time to close out the trade. This can be very frustrating and costly.

Restricting screening criteria to a certain level of options volume or open interest will keep traders from getting involved in thin issues.