Trading Options: An Investment Opportunity or a Career

Trading is similar to any other job or hobby

You cannot wake up one morning, decide to become a trader, open an account, and begin trading. That is you cannot expect to earn money by taking that route.
Trading requires skills and knowledge. These are not learned overnight. And the truth is that some people can never develop the necessary skills. They may be successful investors, but trading is different.

For clarification:

By the definitions used in this post, an investor buys an asset and plans to hold for an unspecified time. The investor’s expectation is that the asset’s value will increase over time, allowing the investment to be sold at a profit.

On the other hand, a trader buys (or sells short) an asset with no long-term plans.Traders tend to hold positions for as little as a few seconds to as long as a day, and seldom own positions overnight. The same expectation is in play: closing the position and collecting a profit.

An option trader is a mixed breed. While we don’t own positions for several years (options don’t live that long), there is also less of an immediacy to exit. I have no statistics, but when I talk about an option trader, I am referring to someone who opens a position with the intention of earning a profit when the market moves (option owner), or time passes (option seller). Thus, the holding period is not known in advance (except for those who always hold until expiration arrives). To me an option trader has a position that takes several days to a few months to bear fruit. Someone who buys LEAPS* options and who plans to hold for a year or two is an investor, not an option trader.

*Long term Equity AnticiPation Security. An option with a longer lifetime.

To many people, the trader’s job sounds easy. In fact, not so many years ago (1990s), brokers were advertising how easy it was to open a trading account and become wealthy. Anyone remember those E*Trade ads? Even though most of those day trader wannabes faded into the sunset, people believe that being a winning trader is not too difficult. For that reason, new traders tend to be overconfident.

With that overconfidence comes a sense of bravado, risk management is ignored, and traders blow up their accounts before they learn whether they have what it takes.

Trading is difficult. It requires a certain skill-set, knowledge and the ability to avoid panic.

Traders do not have to be the best, however they must be substantially better than average. Why? Because the average trader loses his/her stake and leaves the business.

Trading is a serious business, and not a game.

Options Education

If you want to learn about options with the intention of using them to make money – or to reduce the risk of holding other investments – I can help with the education portion of becoming an option trader.

I can help guide you toward understanding what is needed, such as patience, discipline, controlling your emotions – and especially fear and greed.

Developing skills often requires a good trade coach or mentor

Options are unlike anything you ever traded previously. They can be used to hedge (reduce the risk of owning) other assets. They can be bought or sold as a bet on market movement (or lack thereof). If you are unfamiliar with options, there are two major differences between options and other assets:

  • Options have a limited lifetime, and at some point they expire and cease to exist. Options are known as wasting assets.
  • Options are used to measure and manage risk. Too few people understand that aspect of options

Regarding using options as a hedge: The truth is that options were designed as risk-reducing tools, and option buyers own insurance policies. Risk is transferred to the option sellers. Investors everywhere should (ok, that’s my opinion) be protecting their assets by using options. Too few do that, and suffer when the market undergoes one of its periodic tumbles.

Character traits that make you a better option trader

a) Be interested in paying attention to details

b) Be willing to take time to understand options, allowing you to recognize how what is happening in the marketplace affects the value of the options you bought/sold (or plan to buy/sell)

c) Be disciplined

d) Control your emotions. This is very difficult for some personality types.

e) Willingness to devote time to practice

f) Having the patience to defer trading with real money until you are ready

g) ***Understanding that paying attention to and managing risk is necessary for success. It is not just something that helps a little. You cannot succeed (for long) without recognizing the importance of risk management. Do not allow losses to grow to an unacceptable level.; Be willing to accept a loss. Recognize that every trade cannot be a winning trade. Be realistic. Your ego is not involved with the trade, but your financial future is.

Bottom line: You can succeed, but there are no guarantees. Trading is not for everyone. Do what’s necessary and the chances are excellent that you can make money as a trader. How much money? That depends on the size on your bankroll and your trading skills

One of my favorite quotes by Dr. Brett Steenbarger (trader, trading coach, psychologist, former blogger) was in response to my question:

“Brett, do you think it’s important that beginners learn to manage risk right away, or is that something they can postpone until they have some experience and a better understanding of how options work in the real world?”

He replied: “They had better learn to manage risk right away, or else they are likely to have a very short trading career.”

 

 

Good decisions

Trading is all about making good decisions. We look at potential risk (maximum loss), potential profits, probabilities of success and make our trade decisions.  Sometimes the markets behave (move as you hope) and at other time they don't.  Just how badly they misbehave determines your financial results. 

Winning traders do not idly stand by and watch their money disappear when things don't go their way. Traders are active in the trading arena.  They frequently exit losing trades, waiting for a better set of circumstances.  They also protect their assets by hedging, adjusting, and reducing position size.  In short. they learn to take defensive actions to minimize risk – when necessary.

Please (I mean it: please) do not adjust positions every time the market moves one percent. Sure those appear to be good-sized moves and they will affect the probability that your current portfolio is or isn't going to be profitable.  But, there are times to adjust. Just as waiting too long is not a good way to manage risk, so too, adjusting too quickly in ineffective .

That's one reason for making a trading plan.  You will know, in advance when the position reaches, or approaches, the danger zone for you and your risk tolerance.  At or near that zone is the time to make an adjustment.

Over-adjusting is not going to work.  It's expensive, it's overkill.  If you cannot tolerate any risk – then option trading is not for you.  If your risk tolerance is very low, that's okay.  Find a strategy that offers that very low risk (and the low-profit potential) that goes with it.  But if you adjust (out of fear) every time the market makes a small move, you will have a lot of trouble.

Advice:  Open that paper-trading account, open some positions, believe it's real money and see just how frightened you get.  Adjust when you believe it's necessary.  Keep careful records and determine whether you can be consistently profitable.  This takes time.  Be patient.

 

Bottom Line

When you understand the principles behind trading, you have the ability to think clearly and make good trade decisions.  In turn, that increases your chances of having a long and successful trading career.  There are people whoI can help you make better trade decisions.

Many serious-minded traders in training learn to do whatever is necessary to succeed.  A larger number are anxious to begin, skip both the education and practice sessions, and expect to make money.   It's not going to happen.

I can teach you many things.  However, you must know who you are.  Can you control your emotions, or do you panic easily? Can you make difficult decisions in stressful situations?. 

Do you refuse to take a loss and plan to hold all trades until they turn profitable?  If that is your mindset, trading is going to be a very difficult undertaking.

If you get greedy or become easily frightened, you must learn to overcome those habits to become a successful trader.

939

2 Responses to Trading Options: An Investment Opportunity or a Career

  1. DB 04/02/2011 at 3:44 AM #

    Hi Mark,

    Thank you for this post. Heard it many times and read it too about risk management.
    I learned my lesson with “Lehman case” and also when SP500 dropped 1000 points and backed up within 1 hour. With the first case, I did close and forced to close, and the second case I did nothing, and survive. I guest I was lucky.

    Another thing, it is very difficult to learn options virtually (at least for me). It is like learning how to swim. Or to golf, without going to the green, just at driving range. 🙂

    Have a nice weekend.
    DB

    • Mark D Wolfinger 04/02/2011 at 7:26 AM #

      DB,

      We each have our preferred method for learning things. Some love books, some seminars, and there is always the traditional methods used for schoolchildren. If paper trading doesn’t do it for you, you are not alone.

      Being forced to close positions is a horrible feeling. And it’s costly.

      Regarding the ‘flash crash’ I was unable to trade. I believe we were all ‘lucky.’ However, traders with positive gamma who wanted to ‘buy on the dip’ may have been frozen out of the markets. These traders were not so lucky.

      My broker’s platform showed that all options were zero bid and $2,000 ask. Not exactly a market one could trade. The only fills I received were standing orders to cover short calls at a low price. Amazingly I got a couple of small fills.