Educating an options trader

Gaining a sufficient education

The setup: A newbie to the options world is learning about options. He/she picks up certain pieces of information (only those specified) in one sitting or one lesson.

Information packet #1

Let’s assume that you understood this much:

  • If bullish, buying a call is appropriate
  • If bearish, buying a put is appropriate

Education status: Let’s hope that no one believes this information is of much use. Trades made on the basis of this information are likely to result in a loss.

Information packet #2

  • Options are not always reasonably priced
  • Sometimes the trader gets a bargain – increasing the odds of winning
  • Sometimes the trader pays too much – decreasing any chance to earn a profit
  • A reasonable estimate of the fair value of an option can be made

Education status: The intelligent trader knows not to buy calls or puts based on a market bias, but is snot yet ready to begin trading.

information packet #3
Our trader finds a source that explains the basic idea of volatility. Not all the details, but enough to recognize how volatility affects option prices. Enough to recognize that implied volatility (IV) moves from high to low (significantly affecting option prices) in what appears to be a random path. Historical volatility (HV) for a stock is readily available.

Education status:

  • Pay a reasonable price when buying options
  • Understanding the concept of HV and IV allows the trader to trade at more appropriate times and to avoid overpaying for options

Education status: This is enough knowledge to get started – preferably with a paper-trading account. This is nowhere near sufficient, but the trader has a chance to make an intelligent, rather than a random, trade.

The first ‘packet’ was more dangerous than helpful.
The second offers a warning which alerts the trader to proceed with caution.
The third gives the trader a fair chance to pay a reasonable price.
This is enough to enter the game with virtual money.

It is not sufficient. It offers no warning about risk or risk management. The trader stands a chance, albeit a small chance, to earn money.

Information packet #4
Prognostication: It is not easy to predict market direction. Most highly-paid, professional traders cannot do it consistently.

    Personal note: I do not understand why so many people suggest that a trader can learn technical analysis quickly, and with minor effort, and then use charts to predict market direction. Experts tell us that technical analysis is difficult to master, while the hype artists tell us it is a cinch.

    I do not understand why new traders are not immediately taught that being bullish does not mean a stock will move higher. Or that it’s crucial to buy the right options. Or that ‘technical analysis’ is neither easy to learn nor universally accepted.

This information packet is seldom available. Students ‘learn’ that chart reading is easy to master. They believe that being bullish leads to easy profits. This harms most students by providing false confidence.

The truth: Trading is difficult. Making money is not guaranteed. There is no reason to pay high prices for an education.

Education status: Teaching beginners to rely on graphs is harmful. Learning that market prediction is often a waste of time makes a big difference by helping the trader face reality.

Information packet #5

  • It is a bad idea to buy OTM options
  • Buying options requires good timing, as well as picking direction
  • Earning money when buying options is a difficult task. Not impossible, but difficult

Education status: This is more than enough for most people to get started. Unfortunately, it is not the curriculum of many options educators.

The trader who has been exposed to these five packets of information recognizes that the price paid for an option is important and has some idea of how to decide whether the price is reasonable. The newbie learns that there are many factors that go into the decision on buying options. This is more than many beginners get out of their courses.

It is sufficient information. With an idea of when to buy, how much to pay, the importance of timing, the chances of success, the trader’s skill in using charts – a new trader can decide whether to go ahead and spend some time practicing this strategy, or whether to seek another.

Personal note: Far too may ‘educators’ teach so little of what is sufficient and teach only enough to get the novice excited about using options. That works for the educator. That sells more courses and more lessons. The student soon learns that he/she does not know enough to trade effectively, neatly falling into the ‘more lessons’ trap of the instructor.

Students should get sufficient information the first time. Each person learns at his/her own pace, and the time required varies with each person. It is unfair to offer the student too little and then send him/her out to trade.

I’m doing what I can to combat that nonsense, but my efforts are apparently a well-kept secret.

To learn more about my idea of teaching beginners to trade, visit Options for Rookies Premium.

Information packet #6

  • It is mandatory to manage risk with care
  • Appropriate position size is step one in risk management
  • Hedging reduces risk

Does packet #6 add anything of value?

Yes. It completes the ‘sufficiency’ requirement. Enough to make a solid beginning. Lots of practice is required. Skills must be developed and honed, but the student has the background needed for success. Risk management is an essential ingredient of any trading course.

An options education

There are a bunch of well-qualified options instructors. However, some deliberately offer too little – hoping to sell more lessons. Others offer too little because they are not qualified to help traders find success.

When it comes to decision making and the ability to choose trades wisely, too many novices are left to their own devices, instead of being taught the ropes by their teachers.

How is the new trader to judge whom to trust? No beginner knows what it is that must be learned, and is forced to trust the teacher. The truth is that many cannot be trusted.

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