Seven Common Sense Observations on Option Trading

Gary Delany

Advertorial- Although trading options may seem complicated to many investors and traders; Gary Delany, Director of European Marketing and Education at The Options Industry Council, discusses seven observations that he has made while trading options.

There is a lot of information available on using options as a hedging or investing tool, but sometimes it’s hard to see the wood for the trees. Here are seven common sense observations on options trading to keep you focused.

  1. Options are not magic

There is a tendency among some investors to see options as a mystical tool. They are not. In just the same way as you would do your research if you were investing in the underlying security, you need to do it for an option trade. Is the security trading in a tight range? Is it about to spike, up or down? Are you concerned about the impact of a sharp down move on your portfolio?

  1. How much do I know about options?

Of course the answer is ‘never enough,’ but there are some core themes that you need to understand. Here’s a few of them:

Basic Mechanics
Do I understand the contract terms for an option trade – call, put, exercise (strike) price, premium, expiration etc.?

What is the right or obligation of the option buyer and the option seller?

What does at-, in-, or out-of-the-money mean?

Choosing a Strategy
What are some of the typical strategies that market users are employing for hedging or investment?

Do I know how to work out the profit and loss of my position for various price outcomes?

What’s my upside, and my downside?

What is my personal risk profile like? What level of risk – and cost – am I happy with?

Make sure you understand the strategy and its profit and loss implications.

Option Valuation
What ingredients influence an option’s price? What role is played by time to expiration, volatility, strike price, underlying price and interest rates.

  1. What if there are gaps in my knowledge?

Serious option investors will already be familiar with most of the above questions. If you don’t know any of the answers, help is readily at hand on The Options Industry Council website www.OptionsEducation.org.

OIC’s Option Education Program offers the ability to learn online at your own pace. Everything is free. OIC’s focus is investor education.

  1. Practice helps

Paper (practice) trading can be incredibly useful. The Virtual Trading System (VTS) on the OIC website lets you test out real world strategies without risking real world dollars. You can also obtain pricing information using the Quotes section of the OIC website (15 minutes delayed).

  1. Do I have a plan?

We all hope that our strategy works out, but what if it doesn’t – what’s Plan B? Also, what are my exit plans: When do I plan to close the position? What’s my objective?

  1. What practical choices do I have?

All investor profiles are different. One approach might be to start with the stocks that you already own and see what strategies might be used with them. For example, what happens if I write (sell) a call option on them? And how can I buy cheaper protection if the market falls?

To summarise, option trading can be seen as a voyage of exploration, though it’s not necessarily suitable for everyone. We know some of the detail, but not all of it. Taking the first steps can be a challenge, but tools and knowledge exist to help us. It’s by questioning and experimenting that we grow our knowledge and skills.

  1. What are my next steps?

Learn more from the Options Industry Council at www.OptionsEducation.org and get access to online classes, options quotes, a virtual trading system, strategy videos and email access to options professionals at options@theocc.org at no cost.

By Gary Delany, Director of European Marketing and Education at The Options Industry Council, DISCLAIMER: OPTIONS INVOLVE RISK AND ARE NOT SUITABLE FOR ALL INVESTORS. INDIVIDUALS SHOULD NOT ENTER INTO OPTIONS TRANSACTIONS UNTIL THEY HAVE READ AND UNDERSTOOD THE RISK DISCLOSURE DOCUMENT CHARACTERISTICS AND RISKS OF STANDARDIZED OPTIONS AVAILABLE BY VISITING WWW.OPTIONSEDUCATION.ORG. ANY STRATEGIES DISCUSSED, INCLUDING EXAMPLES USING ACTUAL SECURITIES AND PRICE DATA, ARE STRICTLY FOR ILLUSTRATIVE AND EDUCATIONAL PURPOSES ONLY AND ARE NOT TO BE CONSTRUED AS AN ENDORSEMENT, RECOMMENDATION OR SOLICITATION TO BUY OR SELL SECURITIES. PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS. WEEKLYS IS A SERVICE MARK OF CHICAGO BOARD OPTIONS EXCHANGE, INCORPORATED. COPYRIGHT © 2016 THE OPTIONS INDUSTRY COUNCIL. ALL RIGHTS RESERVED.