The Realities of Option Trading
The Options Indexes blog is a guide to trading options from a retail trading account. These notes draw from my experiences with trading options for the past 7 years. Option trading is a large subject which makes it hard for new option traders to know how to get started making safe trades. To make matters worse, the internet is filled with mis-information about option trading. Usually the sources of the misinformation are websites touting options as either a way to “get rich quickly” or as a way to make “safe passive income”. My goal for this site is to distill the subject down to the basic information needed for trading options from a retail trading account and dispel some of the common myths that I see out there on the trading websites and message boards.
Options Need Not Be Complicated
Contrary to conventional wisdom, I personally believe that index options and equity options can be excellent trading instruments for beginning traders once a few basic concepts are learned. Conventional wisdom is that equity and index options are advanced trading instruments for advanced traders. This is not entirely untrue. Option trading can be complicated. It is possible to put a nearly infinite variety of complicated trades on with options expressing different complicated bets on future market direction and specific future price levels. Furthermore there are a number of of risk factors (commonly called “the greeks”) that can be computed and monitored for any option trade. But, is it necessary to know about and place these complicated trades to successfully trade options? No, in fact the vast majority of option trades, even those placed by expert traders, come from a few simple categories of option trades. Do you need to know how to compute all of these various quantitative risk factors? No, with a little experience a basic intuitive understanding of the greeks can be formed, which will allow you to quickly understand the risk factors of any option trade that you are likely to put on.
The Best Trading Instrument for Beginners
So what is it about options that makes them so well suited for beginning traders? The most important thing that you can do when beginning to trade is to control your risk. Nothing else matters more when starting out in trading and investing. Index Options and Equity Options give you the ability to precisely control the quantity and nature of the risk for the trades that you make. When you make an option trade it is possible to control precisely how much money you put at risk, how much money can be made in exchange for taking that risk, and even a rough probability that any individual option trade will turn a profit at the time of placing the trade.
Control Your Risk
This control can be dangerous. Because options so precisely control risk, your broker will allow you to effectively “leverage up” with options and take on very large trades. This is why options have a reputation for being risky. People make trades with options that they simply can not afford. Fools who would never dream of buying 5000 shares of a stock will buy 50 option contracts on a volatile stock the day before earnings and lose most of their account and then conclude options are risky! But in that case, it is not the options that caused the risk. The risk came from the large trade size. (Not to mention the general foolishness that is speculating on earnings announcements.) Index options and equity options are in fact some of the safest instruments to trade as long as you don’t make trades that are too large for your account! Making trades that are too large is the number one mistake that almost every new trader makes. Whether or not you are trading index options, equity options, futures, stocks, etc…you always need to use prudent trade sizing. Options are not unique in this respect.
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