5 Factors to Consider Before Every Options Trade

There are numerous trading techniques to consider for each and every options trade, so Fred Oltarsh at Options Strategy Network details five of the ones he considers extremely vital for trying to put the percentages in the trader's favor.

The key to trading options contracts successfully (individual stocks and futures as well) is to put the percentages in your favor. This involves numerous trading techniques discussed in the Options Strategy Network options guide. Briefly, one should consider the following factors for each and every trade: 1) liquidity or the cost to initiate and liquidate the position, 2) implied volatility or the relative value of the particular option one is trading, 3) having a pre-designated point of liquidation, 4) risk/reward ratio after commissions and slippage and 5) diversification of strategies and trades.

Each analysis described above increases the likelihood of success of an individual trade. Examining the liquidity of the market that one is about to trade is the first step to increasing levels of productivity. If one is buying a stock for a long-term hold, the implications of liquidity are not as great for that trader as for the trader who intends to buy and sell stock frequently. If one is day trading, whether stocks or options, even a bid/ask spread of a penny on a low priced stock, has an impact on the bottom line. The best way to analyze it is to quickly determine the difference of the bid/ask spread as a percentage of the value of the instrument traded. Then determine what that value is per one thousand dollars invested. If the number sounds high, it's probably worth staying away from that trade.

Understanding an option's implied volatility provides a context for the value of the option in not only a historical context, but in relationship to other options in the options series. While implied volatility can be misleading, particularly on options with short durations, for longer durations, it provides the opportunity to analyze significant pricing information in a single number. One is able to compare prices through one mathematical calculation and create options trading strategies which meet their market or volatility bias in a way that looking at prices alone couldn't.

Traders need a plan to enable them to instill discipline into their trading. For some options traders that discipline can be built into their limited risk options strategies, others must set up specific points of liquidation. For traders selling premium, setting up points of liquidation is essential. Losses can increase dramatically due to the Gamma of short options and short options traders are the most likely to experience unmanageable losses. To read the entire article click here.

By Fred Oltarsh, Proprietary Trader and Editor, Options Strategy Network