Learning to Trade Options

In your attempt to search the Internet, looking for ideas on how to successfully begin trading options, you landed here.  You are in the right place.

Here are some tips on how to get started.  Some may seem obvious, but the purpose of this post is to save the options rookie from unnecessary grief:

1) It's easy to understand what an option is.  But that does not mean it's easy to begin trading options with any chance of earning a profit.

2) Do not believe it – when anyone tells you that you will make some very large (and quick) profits when buying options.

3) Most beginners look at options at lottery tickets, spend good money to buy low-cost options and never understand exactly what happened when they lose their entire investment.

4) Read.  Learn.  Ask questions.  I recommend one basic beginner's book and two websites for additional information and beginner seminars.

a) The Rookie's Guide to Options.  Now in it's second printing this book has received excellent reviews and testimonials.

b) The CBOE Learning Center.

c) The Options Industry Council (OIC) web site.

5) Before using real money, open a paper trading account with your broker.  Do not pay any fees to use that account.

6) Pick a broker who specializes in options. Consider Trade King, Interactive Brokers, OptionsHouse, thinkorswim or OptionsXpress.

7) Learn.  Understand what you are doing before you make trades.

8) Please accept this as true for now.  As you begin to gain experience you will understand just how true it is:  Managing risk and limiting losses is the #1 key to long term success.

9) Trade within your comfort zone

a) Don't make any trade unless you understand what you have to gain and how much money is at risk.

b) Adopt a strategy with limited losses
b) Don't make any trade unless you understand what has to happen to the price of the underlying stock (or index) for you to earn a profit. 

c) Don't make any trade unless you understand what has to happen to the
price of the underlying stock (or index) for you to lose the maximum.

d) The concept of 'volatility' and how it affects the prices of options may prove to be difficult to understand at first.  Don't give up.  Understanding volatility is vital when trading options. But don't make it your first priority.


6 Responses to Learning to Trade Options

  1. Brent 08/10/2009 at 8:59 AM #

    To add to the virtual (or paper) trading — When you think you got your system down and are ready to dive in with real cash, wait another month. You are never as ready as you think you are.

  2. Nirmal 08/10/2009 at 9:24 AM #

    Hi Mark
    Please confirm if this is true.
    Today in BLLOMBERG TV, a guy said that
    Goldman Sach stocks VIX is increasing slowly and
    that indicates that the stock is posed to go down.
    Can VIX forecast a stocks future price?
    As usual I believe you more than most experts.

  3. Mark Wolfinger 08/10/2009 at 10:34 AM #

    And some brokers make it unrealistically easy to get orders filled in paper trading accounts. That deceives the trader into believing it’s easier than it really is.
    Thanks for the good advice.

  4. Mark Wolfinger 08/10/2009 at 10:44 AM #

    I cannot confirm such nonsense.
    Goldman Sachs does not have a VIX. It has an implied volatility. It’s important to get the terminology correct – just so we can understand each other and there is no confusion. VIX is an index based on the price of SPX (and only SPX) options.
    VIX has been used as a market indicator by some people. In general, VIX tops out at market bottoms and bottoms out at market tops. But that’s not always true and basing trades on the direction of VIX is risky. But, I would not totally ignore VIX.
    Using IV levels for a single stock is even less reliable. I wouldn’t do it. But it’s true that some people believe IV rises when the stock declines in price. If you take that as gospel, then a rising IV is bearish. But, a rising IV also indicates an expectation of increasing volatility. True, that higher volatility is seen on declines, but there is no reason it cannot be seen on rallies as well.
    One writer on Bloomberg is notoriously wrong when writing about options. He tries his best, but almost always gets his facts wrong and writes misleading pieces. I have no idea who wrote your piece, but I’d guessing it’s my guy. And, I’m not willing to give his or her name here.

  5. lori 09/12/2011 at 10:05 AM #

    i want to learn about trading options.. i know a little already. i went to amazon to buy the book for rookies. but their was a review stating that the book contains nothing about buying puts. now i know buying puts is important if the market is falling (which i expect to see lots more of)…so whats up with disregarding important info? i dont want to buy a book to have to buy another book…ya know? thanx, lori

    • Mark D Wolfinger 09/12/2011 at 10:28 AM #

      Hi Lori,

      (The Rookies Guide to Options). There is no separate chapter on that topic. There are plenty of BETTER ( methods for profiting in a falling market than to buy puts. What the person who wrote the review does not know is that buying puts is a very expensive, high risk method for betting on a down market. Yes, that strategy can produce big profits – but most of the time the inexperienced trader pays too much for the puts, chooses the wrong options to buy, and loses the entire cost of those puts. That’s a loss of 100% of the cash invested.

      Buying puts is a bad strategy for inexperienced traders.

      In the book you will learn how to risk less cash (compared with buying puts) and have a much higher chance of earning a profit in a falling market. Unless you want to earn a fortune, using options conservatively is far better than buying puts and/or calls.

      You will not be disappointed with this book. Promise. Let me know if you have problems or questions