Trading on options hasn’t always been the most favored strategy, and it certainly isn’t the most traditional. Here you’ll find a detailed report on everything from the definition of “Options” to the best tips, pros, and cons of this up and coming method of trading.
Brokers Trading Options
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What Are Options?
Basically, an “option” is a contract that gives the seller the right to buy or sell a specific stock at a predetermined price, within a predetermined time period, and obligates the seller to pay out or buy up the stock before the option’s exercise date and time is reached if the seller wants to enforce his contractually supported right. Options also fall into two categories called “puts” and “calls.” Puts are essentially bets that the stock will fall, and Calls are bets that the stock will rise in value.
Options are available in many markets, and the more traditional ones are normally called the vanilla markets.
What is an Option Contract?
You should be able to recognize an option contract by the following criteria:
- Option Type: Call or Put.
- Type of Security.
- Strike price. I’ll explain that in a minute.
- Number of Shares.
- Expiration date.
As I outlined above, there are two types of options that represent very specific trade movements. This is a more detailed analysis of those types.
- Put – This is a buying option that specifies the sale price you’ll be contracted to adhere to.
- Call – This is the specific purchase price of the option in question.
Here is a semi-extensive list of markets you could potentially trade in, and although you should keep in mind that not every single one is suitable for day-trading, we think you’ll benefit from exploring them all:
- Stock options
- Index options
- Mini options
- Mini Index
- Weekly SPY
- S&P 500
- IRA Accounts
- ES weekly
- In-the-money or (ITM).
- Crude oil.
The Underlying Asset
Options are often based on the shares of a publicly traded company, such as Tesla, JP Morgan, etc. But there are also options that are based on underlying investments, like stock indexes, currencies, commodities, and real estate investment trusts.
With very few exceptions, like splits and mergers, options of this kind are based on 100 shares of the basal stock. This is going to be important information to hold on to if you’re planning on doing this full time.
American options and European options differ slightly from one another regarding the point at which you can exercise your bet. American options can be bought or sold at any point from date of purchase to the date of expiration, while EU options can only be executed on the expiration date. That will have a major influence on your style of trading.
Options vs Futures
If you’re particularly astute, you’ll have noticed that there are several points of commonality between Futures and Options, and not all of them are trivial. From the architecture of their contracts to the base instruments, they have several things in common.
It’s how they are traded that makes up the biggest difference. Trading rules and the array of available options differ widely on occasion, and while, for example, Options can be traded one at a time, Futures cannot.
Why Trade Options?
Just like any high-volatility market strategy, trading with options can make a trader quite a lot of money. Aside from this seduction, there are a few other reasons you may want to look into it.
- Low-cost strategy – Unlike stocks, Options allow you to enter and exit the market with greater fluidity and far less risk. You also don’t need as much upstart capital, in principle, to trade with the same value of any particular stock because you’re not purchasing the basal asset.
- Diversity – You have the potential to diversify with greater speed much sooner than you would if you were trying to allocate enough money to invest in actual stock, and this makes you more competitive.
- Greater benefits – You can profit more and in less time with an Option as well. Think about this: With a regular old stock that you bought at $10 per share, you can make a profit of 100% if it moves to $20 per share. But if you have a call option on contract that is $10, and it moves to $20, you’ll make 1000% profit. Maths are fun.
- Mutually beneficial – Options are indeed founded on stocks, but you can diversify your profit generating potential by selling options on stovks you already own in order to generate more profit.
With nothing but an internet signal, you can start Intraday Trading accessing this multi-faceted market wherever you are.
There will always be a corollary list of cons for every list of pros, and we’d be doing you a disservice if we only focused on the best possible outcomes while providing you with no perspective. Luckily, we have integrity, and what’s more is that a lot of these drawbacks have work arounds and mitigating factors.
- Wide bid-ask spreads – More often than not, because of the liquidity being lower, the bid/ask spreads are wider than with traditional stocks. This can vacillate as much as half a point, which can impact day-trade profits.
- Price movement reductions – The price movement can be limited by the time/value element of the premium of your options. Even if the value the increases with the price of the basal instrument, the gain can be almost entirely cancelled out due to loss of time value. The good news is that the time value for option day trading is more or less restricted.
If you balance out your investment and trading strategy with these potential negatives in mind, they shouldn’t hinder you any more than any other nuance in the market. Juts stay vigilant and keep your goals in mind.
How To Start Trading Options
If you’re a beginner, these few, easy to follow instructions and tips should help you get a head start.
Open A Brokerage Account
There are almost as many brokers as there are styles of trading, and picking one that matches your particular approach while best facilitating your overall goal set, will make a huge difference in the way you progress. You should therefore spend some time doing your homework, and the factors we’ve assembled below should help you make a savvy move. Consider:
- Costs – Fee structures, sign-up costs, deposit and withdrawal fess, interest rates and premium account returns and benefits should all be taken into account when choosing a broker. Commissions on trades, if any, merit special examination if you make a large number of trades a day, as some brokers even offer zero commission trades.
- Account type – Cash accounts and Margin accounts have different advantages and disadvantages. For example, with a cash account, you can trade only with the money you actually have, rather than with money from loans. But if you have a margin account, you can borrow money from your broke. Needless to say, each account type caters to a range of traders, but it will behoove you to inspect your personal style and pick one that best represents your ideal model.
- Platform – The platform you choose can make or break you in the first few months and even has the potential to stall you when you become more sophisticated and find that it doesn’t have the kind of complexity or diversity of use that you once thought. There’s nothing stopping you from finding a new one, but you’ll want to really dig in here and find a platform that suits you.
A useful, effective strategy that conforms to your goals but also keeps you checked against over ambition, is key. Every move you make, every dollar you spend, should be accounted for somewhere in the superstructure of your overall plan. There are a multitude of tools and resources that will help you build a good strategy, and we suggest you start here:
Charts & Patterns
You can always use the news, but unless you’re doing that exclusively (which I don’t highly recommend) you should probably be using more modern, instantaneous means of procuring data and predicting market fluctuations. Charts, patterns and other data sets will be of more use to you than almost any other predictive tool, and you can never have enough data.
A good chart should include any number of the following, and this you can tweak over time to better conform to your personal strategy:
- Put Call Ratio Indicator
- Money Flow Index
- Open Interest
- Relative Strength Index
- Bollinger Bands
This will present you with an, at first, overwhelming amount of data and generalized information, but the harder and longer you work at reconciling what you see with market fluctuation, the more diligent you are, the better you’ll become as a trader.
It may sound contrived to say that timing is important in the world of trading, but it is especially true with options, as there is often a live human being behind these options who is potentially as determined as you are. So don’t forget to be on top of it.
If you’re going to try and grab that early morning worm to assess the climate of the markets that are heading through Europe and coming into the US open, you’d better be up at 0600 ET to ensure you don’t miss anything. From here, based on what’s happened to the market your looking over the previous night, you can begin structuring your trading strategy for the day.
Take special note here that the movements of United States often predict the direction of the world markets, and this means you may want to wait an hour for the market to settle somewhat before locking in your trades.
Here’s an example of a strategy that’s been tested, and works. If the market is inclining, you should buy calls or sell puts. Conversely, if the market is declining you should sell calls or buy puts. Although more than a few traders would rather sell than buy options, some equities move so well that it is better to purchase the option because it can net you greater profits than selling it, waiting for it to go down.
Let’s look at E-mini’s futures contracts. The smart move would be to show a little patience during that first hour, afterward examining where the E-mini is trading based on its open, and whether Apple is trading in the same direction. Follow?
If Apple is indeed trading in the same direction after that first hour, you would want to buy an at-the-money, or first strike out-of-the-money call, if it was rising, or a put, if it is going lower. Then you wait for a half hour to see if you made the right call. Nerve wracking, but that’s the smart bet. If you predicted correctly, you would want to place a stop at half the value of the option you purchased. As an example, if you bought it at $50.00, you’d place the stop at $25.00.
If the market turns downhill, then get out fast. But, if the trade looks good to you, then I’d recommend waiting few hours, re-evaluating before close of day. Track your trade for as long as it takes to get a handle on whether or not you should stick with it, and close strong if you can, there are plenty of other opportunities out there if you can’t.
Tips for Trading Options
Even with the nigh on infinite information at your disposal from the internet, it never hurts to get a little leg up from those who have compiled some useful tips and tricks to help you work around those pitfalls that so often plague the newly initiated day trader.
The best traders are the one’s who never stop learning, processing, absorbing every scrap of data around them that may pertain to their trade. As Arthur Conan Doyle famously wrote, a man should keep in his metal lumber room only the best tools that are likely to aid him in the pursuit of his chosen vocation, and he should take care not to clutter it up with items that get in the way of excellence. I’m paraphrasing, but you get the idea; keep an open mind and learn voraciously, but don’t be overwhelmed by the sheer volume of data, putting yourself in a position of confusion and ineffectiveness. Look at some of these options as a good start:
- Books & Ebooks are always good resources, and many can be had for pennies.
- Courses, online and live.
- Chat rooms and blogs.
- Video tutorials.
- Expert and novice Podcasts
Demo accounts are a thing of beauty, and not only are many free to use on a given platform, but are fully customizable and integrated with your chosen brokers platform, allowing you to get the hang of a new system and test new strategies without putting up any of your own, actual money. You use simulated money. Honestly, these accounts are an ideal tool for traders who want to get used to trading before they go all in, and they ae not difficult to access.
Rules & Restrictions
These can be tricky if you’re not fully aware of the nuances in your country, and the restriction can sneak up on you if you’re not paying attention, only affecting you later on in some cases. This can be severely detrimental to your career if you didn’t plan ahead before investing capital. In the United States, there are FINRA day trading rules on options. If, for example, a trader meets the Pattern Day-Trader criteria, that trader is required to hold an account with at least $25,000 in it at all times. See how that could easily become a problem you can’t fix?
Death and taxes, you’ll need to consider these two crazed specters no matter what during your life, why not when you’re trading too? The taxes levied on different aspects of your trading life will depend on many factors; country of residence, types of trades and what markets, the amount invested, etc. You’ll really need to pay close attention if you want to maximize your potential.
If you’re going into day trading options, one of the tips that’s easiest to understand, especially if you’ve come up with an effective strategy, is to look at some form of software that automates certain processes for you. Some algorithms can execute trades on your behalf, or copy the trades of others and execute them as your own. Automation allows you to make more trades, potentially, than you even could unaided, and when used appropriately, with enough protection, can drastically increase your potential. Nothing will ever replace hard work and intuition in this industry, but a little automation is just another tool that may be able to help you along the way.
Robust risk management is seriously one of the best aspects of any good strategy. If you don’t have a facet of your plan dedicated to risk management, you’re sharp shooting without a trigger guard, and it can lead to disaster.
Consider using the “one percent rule” when developing your strategy. It sounds simple because it is; never risk more than 1% of your account balance on a single trade. After some consecutive wins or, better yet, after you’ve built up a good reputation and some well deserved confidence, you may consider bumping this up to 2-5%, but never forget the volatility you’re up against, and protect yourself.
Take Away Points
In this business, as a Day-Trader, you’re always cultivating two primary objectives. The first is easy: You want to make money. Why else would you be here? The second has to do with risk management: Minimize risk. If you’re looking for both minimization of risk and an increased potential for wealth generation, then options are where it’s at. Options give you the ability to set clear limits on risk, and, more interestingly and uniquely, with them you can but and trade the same options over and over again, continuing to make money time after time. Put simply, options just offer certain opportunities other trading mechanisms do not.
Don’t forget that this is an inherently risky business, but remind yourself that this is part of the game, and don’t let it scare you off. Nothing ventured, nothing gained, as they say. The point is, Options Trading may be right for you, and even though you’ve got to get a lot of other things sorted before you pull the trigger on this kind of trading, it’s like anything else; the time and energy you put into the developmental stages will pay dividends in the long run, so don’t ignore the details.