2 Essential Review Points to Consider Before Trading Options
12/17/2015 8:00 am EST
Fred Oltarsh, at Options Strategy Network, discusses liquidity and implied volatility because comprehending the importance of these two concepts is something that all newbie options traders should be comfortable with before initiating a position.
It is easy to be blitzed with advertisements for binary options and numerous trading systems, but without the essential knowledge of how to structure an options trade, one is likely to lose money in the long run. Advertisements claiming 85% accuracy don’t tell you much. You can make a small amount of money on 85% of your trades and go bust on the remaining 15%. At Options Strategy Network, our goal is to help you design the appropriate strategy, given your market inclination, in order to have the greatest likelihood of success. The risk of trading options—beyond directional issues—is in not understanding the importance of liquidity and implied volatility.
If one is relatively new to options trading, there is a lot to learn before one should trade. Many people learn by doing, but it can be an expensive way to prepare for profitable trading. In many of my recent articles I’ve discussed particular markets and direction. Taking a step back, options traders should be comfortable with the following concepts before initiating a position. Whether you are an active trader or just getting started, here are some essential review points to consider before trading.
Liquidity: Trading options in stocks or commodities without a high level of liquidity becomes very expensive for the individual trader. If a spread is 25 to 50 cents, chances are that you are giving up a significant edge every time you trade. If one initiates a position, gives up the edge, liquidates the position and gives up the edge, and pays commissions, they have to be a phenomenal directional trader to make money. Trade futures and stock options with extremely small bid/ask spreads and your level of profitability will increase (all things remaining equal).
Implied Volatility: Analyzing implied volatility and the volatility skew enables a trader to make comparisons of value. In stocks, particularly, the downside puts have significantly higher implied volatilities than the calls. Evaluating implied volatility versus historical volatility gives the trader a perspective to create positions that meet one’s directional preferences. The implied volatility lends a significant amount to this analysis and assists the trader in using the most appropriate options strategy for their risk:reward goals.
Traders who evaluate liquidity and volatility in an effective manner increase their potential profitability enormously. It inspires them to choose from a plethora of options strategies which meet their risk:reward profile and can encourage limited risk trading. At Options Strategy NetworkTM, our goal is to educate traders to initiate positions with the greatest success of profitability.
Options trading involves significant risk and is not suitable for every investor. The information is obtained from sources believed to be reliable, but is no way guaranteed. Past results are not indicative of future results.
By Fred Oltarsh, Proprietary Trader and Editor, Options Strategy Network