Before You Make Your First Options Trade

It's understandable that you are anxious about using options.  Maybe a friend told you how much money he/she has made with options, making you anxious to get started.  Or perhaps, the term 'options' makes you nervous because of some horror stories you may have heard.

The truth is that options are not the path to instant riches.  Nor are they something to fear.  Options are designed as risk-reducing investment tools.  If used conservatively (and that does not mean seeking small profits), options increase your chances of making a profitable trade (when compared with simply buying or selling stock).

Too many rookies have no idea how options work, and dive right in, by making some trades and then hoping for the best.  Let's get one thing straight right now: Hope is not a strategy.

If you have a bit of patience, these Minyanville posts will provide some good information to help you get started trading options with a good understanding of how they work.  If you are in more of a hurry, I recommend my recent book, The Rookie's Guide to Options.  Sample vesion here.

If you are reading this at Minyanville, then you will find posts by several others bloggers, covering an interesting variety of option topics.


Before You Get Started

It's important to state that options are not stocks and must be handled differently. In simple terms, the price of a stock is driven by supply and demand, and that in turn, is often driven by news events or rumors.

Options are derivatives.  That means the value of an option is derived from the value of something else.  That something else is a specific stock or stock index.  The pricing of options is much more complex – and that means there are other factors at play, in addition to the price of the underlying stock. We'll talk about those factors later on.

Many option rookies are dismayed when they purchase an option only to discover that the price of an option shrinks overnight – even when the price of the stock moves in the direction the rookie had predicted.  While that 'surprising to a rookie' event occurs, the seasoned option trader knows that the price collapse was a reasonable expectation. I'll make sure you understand why that happens so that you are not on the wrong end of one of those 'surprising' events.

If you don't yet understand how options are priced in the marketplace, then you should not be willing to make trades using real money.  It won't take a huge effort on your part to get up to speed, but too many novices are in a rush to get started and soon learn that buying calls when bullish and puts when bearish is not good enough.  There's much more to understand about using options.

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