10 Must-Have Option Skills

06/09/2015 8:00 am EST

Focus: OPTIONS

These ten characteristics are among the skills and competencies that allow traders to thrive in the world of options. They make for worthy focal points for traders hoping to further develop and succeed, says Manish Sahajwani of Investopedia.com.

Options are among the most versatile instruments in the financial markets. They are flexible in that they allow you to leverage your position to boost returns, manage risk by using them for hedging, or make profit from upside, downside, and sideways movement in the market.

Despite the many benefits, however, option trading carries substantial risk of loss and it is very speculative in nature. It's not for everyone and not everyone can become a successful options trader.

Like any other business, becoming a successful options trader requires a certain skill set, personality type, and attitude. This article will help you understand the ten must-have characteristics for becoming successful in options trading.

Manage Risk

Options are high-risk instruments and it is important for traders to recognize how much risk they have at any point in time. What is the maximum downside of the trade? What is the implicit or explicit position with respect to volatility? How much of my capital is allocated to the trade? These are some of the questions that traders will always have to keep in their minds.

Traders also need to take appropriate measures to control the risk. In particular, if you are a short-term options trader, you will regularly come across loss-producing trades.

For example, if you hold a position overnight, your bet may go bad because of adverse news. At any time, you need to be able to minimize the risk of your positions. Some traders do so by limiting their trade size and diversifying into many different trades so that not all their eggs are in the same basket.

An options trader also has to be an excellent money manager. They need to use their capital wisely. For example, it wouldn't be wise to block 90% of your capital in a single trade. Whatever strategy you adopt, risk management and money management cannot be ignored.

See related: Tough Talk About Risk Management

Know Your Numbers

While trading options, you are always dealing with numbers. What's the implied volatility? Is the option in-the-money or out-of-the-money? What's the breakeven of the trade? Options traders are always answering these questions.

They also refer to option "Greeks," such as Delta, Gamma, Vega, and Theta of their options trades. For example, a trader would want to know if their trade is short Gamma.

It is important for the traders to be able to easily calculate and interpret numbers. You don't need to be a rocket scientist, but you should train as an aspiring "quant jock." (Understanding price influences on options positions requires learning Delta, Theta, Vega, and Gamma.)

See related: Know Your Option "Greeks"

Practice Discipline

To become successful, option traders must practice discipline. Doing extensive research, identifying opportunities, setting up the right trade, forming and sticking to a strategy, setting up goals, and forming an exit strategy are all part of the discipline.

A simple example of deviating from the discipline is to go with the advice of the herd. Never trust an opinion without doing your own research. You can't skip your homework and blame the herd for your losses. Instead, you must devise an independent trading strategy that works for your situation.

Be Patient

Patience is one quality that all option traders have. Patient investors are willing to wait for the market to provide the right opportunity, rather than trying to make a big win on every market movement.

You will often see traders sitting idle and just watching the market, waiting for the perfect time to enter or exit a trade. The same is not the case with amateur traders. They are impatient, unable to control their emotions, and they will be quick to enter and exit trades.

NEXT: Match Your Trading Style with Your Personality

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Match Your Trading Style with Your Personality

Each trader has a different personality; therefore, each trader should adopt a trading style that suits his or her traits.

Some traders may be good at daytrading, where they buy and sell options several times during the day in order to make small profits. Others may be more comfortable with position trading, where they form trading strategies to take advantage of unique opportunities, such as time decay and volatility. And others still may be more comfortable with swing trading, where they make bets on price movement over periods lasting five to 30 days.

See related: What's the Perfect Market for You?

Read and Understand News

It is crucial for traders to be able to interpret the news, separate hype from reality, and make appropriate decisions based on this knowledge. You will find many traders who will be eager to put their capital in an option with promising news, and the next day they will move on to the next big news. This distracts them from identifying bigger trends in the market.

Most successful traders will be honest with themselves and make sound personal decisions, rather than just going by the top stories in the news.

See related: Trade Headlines without Becoming One

Learn from Losses

The Chicago Board of Trade recently reported that 90% of options traders make losses. What separates successful traders from average ones is that successful traders are able to learn from their losses and implement what they learn in their trading strategies.

See related: Bouncing Back from a Losing Day

Be an Active Learner

The financial markets are constantly changing and evolving; you need to have a clear understanding of what's happening and how it all works. By becoming an active learner, you will not only become good at your current trading strategies, but you will also be able to identify newer opportunities that others might not see or that they may pass over.

Plan Your Trades

An options trader who plans is more likely to succeed than one who flies on instinct and feel. If you don't have a plan, you will place random trades, and consequently, you'll be directionless.

On the other hand, if you have a plan, you are more likely to stick to it. You will be clear about what your goals are and how you plan to achieve them. You will also know how to cover your losses or when to book profits. You can see how the plan has worked (or not worked) for you. All these steps are essential to developing a strong trading strategy.

Maintain Records

Most successful options traders keep diligent records of their trades. Maintaining proper trade records is an essential habit that can help you avoid making costly decisions. The history of your trade records also provides a wealth of information that can help you improve your odds of success.

See related: The Right Way to Journal Your Trades

The Bottom Line

Top options traders get a thrill from scouting and watching their trades. Sure, it's great to see a pick come out on top, but much like sports fans, options traders enjoy watching the whole game unfold-not just finding out the final score.

These characteristics will not guarantee your success in the options trading world, but they will definitely increase your chances at it.

By Manish Sahajwani, contributor, Investopedia.com

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