Starting off in options can be difficult. There are a lot of moving parts happening within options and there is an abundant of information readily available. The problem is it is often difficult to figure out what information to trust and what information you should begin at.
Your first step will be to get a couple of resource books. Once you have an idea of what is going on you need a place to trade so finding a broker is a must. The last step is finding a good mentor. Mentors are great to speed up the learning process while cutting down on real-world education cost.
We will show you how to handle each of these steps and then how to take them and your option journey to the next level. First see why option trading has its advantageous. Then find out how to discover your own option trading niche and which strategies you should begin trading with.
What You Need To Read About Options
The great thing about the internet is that it has made available tons of resources about all subjects. The bad thing about the interest is that it has made available tons of resources. Resources are great if you know what you are looking for but if you are trying to figure out where to start on a new journey finding that first step can be difficult.
Learning through internet blogs can be difficult because there is not a beginning and an end. We like to start with a good book on the subject because there is a beginning and then a logical progression until it gets to the end. You are not left jumping back and forth between links trying to find definitions and what certain terms mean.
We recommend picking up at least two books to begin your option learning process. The first book needs to be your heavy hitter, your bible. You don't want this book to focus in on any one subject and to take you from beginning to end. By the end of the book you should have a basic idea of what options are, how they look and what the different terms are associated with them. Our option bible was "Options As A Strategic Investment" and we highly recommend using it as yours.
Your second book should be a quick go-to resource. When trying to see what an option strategy's profit and loss graph looks like or how theta weighs in on an iron condor you shouldn't have to flip through your bible. Think of this book as your desk book. There when you need it for an easy flip through when you have a quick question that needs answered. We've already put together a great go-to resource for you with our Free Option Learning eBook. Each option strategy is laid out in an easy to access and read manor.
Finding Your Option Broker
Finding a broker is an essential part of trading. Through your broker you will enter your trades and track your positions. With all the brokers out there which do you choose? Should you go with the broker that has the best commissions or perhaps the broker that has the best option tools? First let's say that you are not married to your broker. Who you choose now does not have to be who you end up with in the long term. Find one to meet your current goals and move on when your goals change and you are no longer being fulfilled.
As an option rookie it may seem like a good idea to go with a broker that has superior option trading tools. However, you will not be able to take advantage of those tools for quite some time so tools should not sit as your highest priority. What you need to focus on is low commissions and reliability. As you learn you are going to make a lot of stupid mistakes and those mistakes don't need to cost you a lot. You also don't want high commissions raising your breakeven prices and make it difficult to churn out a profit. A reliable broker is just a necessity. Cheap commissions are no good if you cannot log in to trade anything because your broker is down.
Take a look at our Top 5 Option Brokers and see how they rank on commissions, reliability and tools.
Getting An Option Mentor
Mentors are a great way to pick up helpful experience. A mentor will help guide you on your path while instilling the knowledge they have learned over the years. There is no better learning tool than a qualified mentor, but finding a mentor can be difficult.
When finding a mentor you want to find an individual who is in a place or roll that you yourself would like to be in. There are a lot of great option traders out there doing things for themselves, running newsletters, trade desk or hedge funds. Which one of these do you aspire to?
Once you answer that question start finding your candidates to be a mentor. Instead of just asking them to be your mentor, which will lead to a definite no, introduce yourself to them and establish a relationship with that person. Try to find ways to bring something to the table. Everyone has something to offer and if you can find a way that you are helpful to them then they will be helpful to you. Show your would-be mentor that you are dedicated and that you've come a long way on your own. Remember, somebody worth being a mentor is busy and is probably being asked for their time on a consistent basis. Find a way to stand out.
Option Trading Advantageous Versus Stock Trading
Stock trading is so cut and dry. You go long or you go short, you profit if the stock goes up or if it goes down. That sounds boring to us. With options you can do so much more. Sure you can profit if the stock goes up or down but now you can also profit if the stock doesn't move, volatility increases or decreases, or just by letting time pass by. Once you begin to learn options don't get stuck in basic strategies. Venture out and learn the other strategies you may just find your next favorite strategy.
Options hold one major advantage over stock trading for new traders. Ready for it? They are cheap to trade. Let's look at a scenario
The Option Prophet (SYM: TOP) is trading at $50 and I want to go long. I am hesitant to go long 100 shares because the cost would be $5,000 and that is my entire portfolio. Instead I go long 25 shares so it only cost $1,250 but commissions still cost $4.95 each way. What is your breakeven on this trade?
Total cost of trade: 1,250 + 7.95 + 7.95 = 1265.90
Cost per share: 1265.90 / 25 = 50.64
64 cents may not seem like much but TOP would have to climb 1.28% for me to even begin making money. With options commissions are much lower and the price of the option is far less considering it allows you to control 100 shares.
Options allow you to trade small batches and still be able to profit. You don't need to buy or sell 5, 10, 50, 100, etc... contracts to make money. You can trade 1 or 2 contracts and still make money. This is handy for a new trader because it allows them to take small positions that won't make them rich but also won't make them poor. Anytime you are learning a new strategy you should start with the minimal contract size that you can. This is a great way to see how options behave in the real world while making sure you won't blow out your account with a mistake.
Let's say your broker charges your $1 per option contract that you trade, and the option you want to purchase cost $2. We know that options control 100 shares at a time so that contract will actually cost $200 (2 x 100).
Total cost of trade: 200 + 1 + 1 = 202
Cost per share: 2.02
That .02 still represents a 1% move in the option but a 1% move in an option's price is a lot easier to achieve than a 1% move in a stock's price.
Finding Your Option Trading Niche
There are a lot of different ways to trade options just like there are different ways to trade stocks. In stock trading you need to decide if you are going to be a value investor, technical analyst, day trader, swing trader or long term holder.
While some of those still apply to options it can be boiled down into two major categories: net buyer of options and net seller of options. A net buyer of options likes to be predominately long options which include strategies such as long calls, long puts, long straddles, long strangles, etc... Typically it means they are going to pay a net debit which keeps their risk low and reward high (not always the case but in general it is).
A net seller of options is the opposite. This trade will like to be short options which include strategies such as short calls and puts, short straddles and strangle and volatility increases or decreases. Typically they will receive a credit for placing the trade which will keep their profit capped and their risk more substantial.
Both of these two groups have their advantages and disadvantages and as an option trader you will gravitate to one. We've never seen an option trader master both of those roles. Which role you fall into will depend on you and your trading. We recommend trading a bunch of different strategies at the beginning and you will begin to see which one you have more success with and which one you enjoy more. Obviously we are the net sellers of options.
What Strategies To Start Option Trading With
Most new option traders are taught to focus in on two strategies: covered calls and cash-secured puts. The reason these two are suggested is because they are pretty risk-less. They also don't teach you anything about options nor are they easy to do for beginners. To initiate a covered call you have to have at least 100 shares of a stock and then sell a call on those shares. That sounds easy enough but if you are only working with a couple of thousand dollars in your portfolio picking up 100 shares of something will be difficult.
The same goes for a cash-secured put. It assumes you have the cash to be able to buy 100 shares of a stock if your stock drops enough that your short put is in-the-money.
When starting out with options don't limit yourself to two strategies. Explore the various strategies that are out there, and there is a lot of strategies to explore. However, before going in guns blazing remember what you have learned here. Make sure you have read about that strategy and understand the basic components of it and the goals it will achieve. Have a broker that has cheaper commissions so you can try these strategies without eating up your portfolio. When you do try these new strategies start small only trading 1-2 contracts each time. That way if you lose or make a mistake it won't cost you a lot of money.
Options can be a lot of fun once you begin to learn and master the various strategies it has to offer. Taking that first step in your option journey is the most difficult. With so many resources available it can be hard finding one to lead you down the correct path. Start with a book that has a natural progression of learning. Find a good starter broker and begin small when you make your trades. As you get better and learn more about how options move and react in the market you can begin to increase your size of trade. If you can find a good mentor you will shorten your learning curve by having experience on your side.