In finance, an option is a contract that grants the holder the right to sell or buy a certain asset, whether it’s mutual funds or stocks, at a fixed price. In other words, it grants the bearer rights, but not an obligation.
Similar to stocks and other assets, options are traded through brokerage accounts. What makes options alluring assets is that they have good potential to diversify the investor’s portfolio and allow them to gain leverage when trading.
6 Best Tips for Better Trade Options
To help you trade options in the most practical and profitable way, we’ve created a list of the best 6 simple tips you can use.
1. Options as Extensions
As a trader, there are a lot of variables that can put a wrench in your gears. You’ve probably experienced the dilemma of not knowing whether you should keep holding on to a stock or sell it quickly before you start losing money. Options are there to give you the flexibility that allows you to take the time to properly plan.
When you are dealing with stocks, you have to completely rely on your ability to predict the stock’s direction in the market, which isn’t always accurate. This can be problematic when there is a lot of capital involved. Options can lower the risk and capital loss, making them a great way to extend your options and express your investment interests.
2. Using Call Options Properly
If you believe with a good degree of certainty that the price of an asset will decrease, you should write a call options contract. As mentioned by the seasoned traders from NetPicks.com, call options should be bought or held when you are waiting for the price of an underlying asset to dip.
On the other hand, if you don’t think that the asset will devalue, you should be quick to sell the call options. Buying or holding a call option is considerably safer than writing a call option contract due to the lack of requirements and obligations that come with it.
3. Thorough Assessment of Options
It’s important to understand that options trading is more complex than trading stocks or other assets. You should avoid attempting to trade options if you are not fully aware of their potential and how they can work. Adding some education and experience to your trader’s toolbox will go a long way when you are trading options.
Your assessment of options should always include risk analysis, goals, timeframes, taxation fees, and liquidity potential. This will help clear up your goals as you begin to fully realize the risks and rewards that you are looking for.
4. Utilize Greed and Fear
When looking for the best option trades, it’s important to distinctly differentiate between greed and fear. In simple terms, you should avoid a trade that has garnered the greed of others and go for trades that others are afraid to make.
Sometimes going against the flow of trade can improve your odds. As stocks continuously fluctuate and revert to baseline prices, trading options can turn fear and greed into profit.
5. Don’t Be Afraid of Using Volatility
The options trading market thrives on the volatility of the stock market. Volatility is one of the things that are overlooked by options traders, but the significant shifting of asset prices of today is putting the ball in options’ court.
Options don’t necessarily have to move in the same direction that the stock is moving in. Implied volatility is an important concept that you need to grasp well to understand the movement of options. It is the volatility that the market expects for the near future of an asset.
Based upon this expectation, the options can increase in price while the stock is going in a relatively positive direction; that’s mainly because of the instability that the market is indicating for a certain asset. This is why it’s essential for an options trader to become familiar with both implied and historical volatility to make accurate assessments of options.
6. Risk Management
Trading options require a dynamic that’s fast-paced and active. You should expect to change the narrative of options trading when it’s necessary. You can’t exactly buy options and forget them, expecting them to somehow come up with a profit. To be able to manage your risk properly, you need to keep a close eye on your trades.
- Closeout trades by offsetting the trade with another option
- Don’t be afraid to let an option expire
- If you find it necessary, replace an option that is about to expire with an identical one with a more convenient expiration date
Many people are familiar with stocks and how they work, but options trading is not a very familiar concept. It is a bit overwhelming at first if you are a complete beginner because it has an additional layer of complexity, but once you grasp the essentials, you should be able to notice the right patterns. Take the time to research as much as possible before you begin trading options unless you are eager to lose money.