How Should a Beginner Approach Option Trading?

The following question seems rather tame, but it addresses a very important issue:

Is there a correct syllabus for new option traders?

Hello Mark,

I’ve just starting to read your Rookie’s Guide book, bought from Amazon. I also read several other options books, while doing my paper trading with OptionXpress with thinkorswim platform.

I also have joined an options course and what they teach are very basic, which is just Buy To Open (Call / Put) and Sell To Close (Call / Put) and pay attention to the candlestick chart for entry point. So making profit from that simple strategy. What do you think of that strategy? They didn’t teach any strategies mentioned on many options books.

Candlestick Charting

Candlestick Charting

But after reading couple of books on options, they all teach the Covered Calls as basic strategy, which from my understanding that one investor has to have real stocks in order to make the options trading. Do I need to buy real stocks? Is that true?

How about if we only open an options account, and didn’t have a real stocks to trade in that Covered Calls strategy? And why I can’t trade the Covered Calls in optionsXpress? Please help me.

Thanks in advance,
Aldo Omar

Paper trading is an excellent idea. It teaches you how to handle your broker’s platform and it gives you experience learning to make critical decisions — entering and exiting positions.

However, this course is a disgrace, in opinion. I do not care how respectable the course giver is, but these lessons are almost guaranteed to see their students go broke when using options. Unless they explain that the course is designed only to teach you something about options and that “buying to open and then selling to close” is NOT a strategy that you ever want to adopt, they are doing you a great disservice. I hope this course is free because it is not worth even that much.

  • First; A trader, and especially a new trader, cannot be expected to know how to use Candlestick charts. It is extremely difficult to “pay attention to” charts and come away with useful information. Think of this way: Candlestick charting is well-known and used my millions of traders around the world. Despite that, the data is clear: The average individual investor does worse than the S&P 500 index. The average mutual fund manager — someone who ears big bucks to pick winning stocks and beat the market averages — cannot beat the averages. Do not get trapped into believing that you can read one or two books on charting and know how to sue the charts. My conclusion is that it is far more difficult to pick entry points than your course teachers suggest.
  • Second; You are learning the simplest of all strategies, and that is a good thing because one should begin with the most basic concepts of options. However, it should have been mentioned as often as possible that buying to open and then selling to close is a death wish. Unless you (A. O.) have a proven track record of predicting which stocks will rise and fall, then you must not — for your financial well being — believe that you can suddenly start trading options and become a successful stock picker. Life does not work that way and using Candlesticks will not turn you into a successful stock picker. The professionals cannot predict stock direction on any consistent basis, and neither can you
  • Third; Even if you work diligently and learn to read the charts successfully, there is more to “buy to open” than simply picking a stock and correctly forecasting the direction of the stock price. Did they teach you that buying out-of-the-money options is not a viable strategy? Did they teach you to pay attention to the implied volatility of the options? In fact, did you learn anything at all about volatility and how crucial it is to an option trader? I assure you of this: If you but out-of-the money options and if you buy them when their prices are relatively high, you will ruin your trading account, even when you get the stock direction right. My advice: If you are going to play the “buy to open” game, at least stick with options that are already several points in the money when you buy them.
  • Fourth; I know that advanced strategies cannot be dumped into the lap of a beginner. Building a sound foundation in option basics comes first. But that is no reason to teach a strategy where the vast majority are guaranteed to fail.
  • Fifth; Yes, covered call writing is a sound basic strategy and yes, it does involve the purchase of stock (in multiples of 100 shares). However, it is still a bullish strategy and the covered call writer can still lose a lot of money if the market takes a dive. Obviously you lack the cash to buy stock. That is okay because there are other ways to use options to generate exactly the same profit/loss profile as writing covered calls. You will get to that in Chapters 13 and 14 in the book that you are reading (The Rookie’s Guide to Options; 2nd edition).
  • Last; The whole idea about using options is to hedge (reduce) risk and still give yourself a good probability of earning a profit on any given trade. Buying options based on Candlestick chart reading is not one of the paths to success. Sure some people can do it, but you don’t want to count on being one of them. Covered call writing is “better” for the new trader – but only when he can afford the downside risk. However, there are other strategies that I would recommend for you. At the top of the list is “credit spreads.” But please have patience. Don’t jump to the chapters on this and related strategies. Go through the lessons at your own pace and if possible, resist the temptation to trade until you feel comfortable.

Aldo,
I hate that course and the sad fact is that this is popular stuff taught by many people.

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