Tips for the Options Trader with a Stock Trading Background

Oct 24, 2012 -

Why You Should be Trading Options?

Many of us solely trade stocks. Why? Because it is easy to just buy low and sell high or short a stock when it is high and cover when it is low. It is pretty straightforward. To make money doing this is a different story, but executing the trades are easy. 

I've always stayed away from options because I had the perception that they are ultra risky. There are numerous factors to consider that affects the option price. For example, if you buy a call option, everyday your option is losing its time value. Now you can make some of that time decay back with intrinsic value, but that's not guaranteed. What is is that your options will lose time value with each passing day.

But, I was looking for leverage. For maybe a third of the money, you can control about the same amount of shares as if you were to buy it outright. While you may not be considered a shareholder and thus not be paid dividends, this is the leverage I was looking for. My account had been stagnant and gains were coming, but not fast enough. I know I have a solid edge, but needed more leverage. This is where options trading comes in.

The downside is that your losses can come just as quick. It's easy to see 50%-100% swings in your position if you pick a volatile stock/option.

In order to education myself, I went to the local library and checked out about six different options trading books. Of course, you can't just read one, you have to read a breadth of books. Otherwise you will be fixated to think a certain way, when in fact there are multiple option trading techniques and factors to consider.

Here are a couple tid bits I took note of:

Remember take these tips with a grain of salt.

1) In order to create an option position that is virtually the same as a stock position, you should buy in-the-money options.

2) Lock in your profit - Let's say you bought ABC June 20 calls for 2 each when the stock was 20. The cost was $2000. Now ABC stock rallies to 25 and your calls are now worth 5. You see that July 25 calls are selling for 1.5. You could  sell your June 20 calls for $5,000 and buy the July 25 calls for $1,500. Thereby locking in your gains and still holding options in case there is more upside. The worse that can happen with your July calls is that it expires.

3) Buy Put options to offset stock movement if you want to hold the stock for the dividend/tax purposes. This reduces the stock's value by the cost of the puts, but also ensure any in-the-money declines in the stock's price will be offset by gains in the puts' value.
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