Why trade options? One of my favorite reasons is the leverage it provides and can be used speculatively, but traders can also learn to use options for creating income or hedging, says Danielle Shay of Fivestartrader.com.
The primary reason why I got into trading options was that it was an avenue that allowed me to get into the stock market with a much smaller account than what I would have needed to make the same impact by trading stock alone. Of course, this comes with risk as well. This is why trading options should also come with your personalized risk tolerance plan. I like to keep my options trading separate from my long-term stock accounts and retirement investments.
This enables me to speculatively trade my riskier strategies in one place while also growing assets with less risk in alternate accounts. Options can be traded with either cash or margin accounts (I have both), but they should also be traded with the understanding that options expire, unlike shares of stock. If your speculation isn’t correct by the timeframe in which the option contracts expire, you can lose your investment. Unlike buying shares of stock, your ability to give it time to come back is limited.
As such, I usually place trades with about 1-2.5% risk on my overall account, and I don’t usually go above 20% account risk at any time. This is because, in the stock market, anything can happen! It’s essential to protect yourself so you can live to trade another day. This kind of risk allocation works for me, but this could be entirely different for you. That’s the beauty of being a trader! There is so much individual choice and freedom. So, how does one work from the idea of options trading to actually focusing on a specific strategy and setup?
Learning Options Trading Step by Step
In speculative options trading, traders need a good idea of their risk tolerance and goals, and this will lead them to what kinds of strategies and setups they want to trade. All of this information helps to give them a framework for where to focus. It also makes sense for traders to learn options trading in a logical, stairstep fashion. Because there is so much to learn, it can be overwhelming if you don’t take it one step at a time!
Generally, when it comes to specific options strategies, buying options like long calls and debit spreads is the first step, as it’s a natural step for many comfortable buying and selling stock. Afterward, traders often get into methods of putting on bearish positions, such as buying puts. It’s only after that that traders can generally dive into selling options. After this, traders can get into more complex strategies like selling iron condors over earnings reports or buying bullish butterflies for short-term directional trades.
This is the natural progression and the most manageable progression to teach and learn options strategies.
With all this in mind, there is much to learn, and a seasonal schedule dramatically helps! One of my favorite periods to speculatively trade options is around earnings season. This is because earnings season occurs four times per year, one of the main events the stock market can count on without fail. This is why developing strategies and patterns to trade it makes sense. These strategies and patterns can be honed each quarter, year after year.
Some of my favorite earnings-related patterns include:
- Trading either a run-up into an earnings report,
- Trading a fall into an earnings report
- Selling options for IV crush before earnings
- Trading big momentum moves post-earnings.
Do you like trading earnings? It’s funny because when I started trading, I avoided earnings entirely due to the volatility and perceived uncertainty around it. But now, it’s most of what I do!
Learn more about Danielle Shay at Fivestartrader.com.