How to Get Started in Options
01/11/2013 2:00 am EST
Steven Place has some concrete suggestions for those starting out in options trading and where to look for the most liquid option series.
My guest today is Steven Place with InvestWithOptions.com, and we're talking about what you need to know to be a successful options trader and how it may be changing now. So, Steve, what do you have to do to be a successful options trader these days?
I'm a big fan of not sticking to a single strategy day in and day out. There are going to be different markets, there is going to be different volatilities, and you need to have different strategies to account for that. A lot of people come into options trading thinking strictly directionally. They think, you know, up or down, and we think about that in stocks and commodities and forex and bonds and everything like that, but you not only need to care about, you know, up or down, long or short. You also have to care about how fast is the market going to move, how long is it going to take to get to your profit targets, too.
So, how many strategies should I have in my arsenal, if you will, to be able to implement? Do I need four or five ones that I'm very good at, or what do you suggest?
You can generally break up options strategies into two kinds. You have directional trading and non-directional income trading. Directional trading is where you speculate on the movements of the underlying stock, and then income trading and non-directional trading you speculate, saying you know, I think this market is going to be range-bound for a certain period of time. So, when you do the directional trades if you get stopped out, if you get chopped up, the non-directional income trades will help to absorb some of those losses, so in the directional strategies you have things like verticals and single puts, single calls. Non-directional we have things like butterflies and iron condors. So, that's a pretty good way to diversify your portfolio against different volatilities.
What do you suggest in terms of learning these? Starting with an individual's put and call, and then working your way up to spreads and that sort of thing?
um, actually, I don't suggest people start with just single puts and calls. There are other risks to options known as the Greeks. So, you not only have delta, which is direction, you also have gamma, theta, vega, rho, vanna, vomma, and so on. Single options have a lot of vega risk and they have a lot of theta risk, okay. I'm a big fan, if you want to start directionally, learn vertical spreads first because those have very little gamma risk, they have very little theta risk, and it's mainly a directional play, and it's very simple to understand. You have a limited risk, limited reward, and you have a specific set of odds to trade against, as well.
All right, and then for somebody else who's getting started; should they start with an index option or a specific stock, or what do you like there?
The best thing to do is to go to the CBOE Web site and look up the Penny Pilot Program, and this is an Excel, or a .CSV spreadsheet of about 300 stocks that have the best liquidity. Liquidity is key when you're going to be trading options. If you don't have the liquidity, if you're trying to exit, you're going to incur a lot of slippage and more losses than you like, so that's a good place to start. Indexes are good. A lot of people in smaller accounts probably want to stay away from cash-settled index options, like the SPX and maybe go to the SPY, because it's a little smaller and it's a little more liquid than the others.