Things to Remember When Trading Options

There are a number of advantages that options trading offers to traders. The level of flexibility offered by options is one of the main reasons why it has endeared itself to millions of traders around the world. One can trade in options even with a lower amount of capital and expect to make handsome profits. However, the reverse of this is also true – options trading is considered high-risk and one can lose substantial amount of money in a single trade. Therefore, it is important to take calculated risks while having a plan of action to trade in a profitable manner. Let’s take a look at some things you should keep in mind while trading stock options.

• Trading with a plan

This is true for every type of instrument that you trade in, be it equity, forex, bonds, etc. You need to create a plan before you put your money at stake. A definite plan keeps you in check and ensures you don’t let your emotions get the better of you. Having a plan is more so important in options trading as you have the pressure of making a profit within a set timeframe.

You need to have a definite plan of action on when you need to exit, irrespective of whether you are making a profit or loss. Once the price goes below or above your downside and upside level respectively, you need to come exit that particular trade and move to the next one.

Bottom line: You need to have a strategy in place and ensure that you stick to it. You will be risking your trade if your wait thinking that the profit will get bigger and the loss will turn into your favour.

• Don’t Double-Up to Recover Old Losses

Options traders should understand that they are trading in derivates and the price movements aren’t really along the lines what one would expect from an underlying stock. Doubling-up to recover previous losses reduces the per-contract cost basis of the entire trade. Therefore, it’s important that you don’t give into the temptation of recovering everything you might have lost in an earlier trade.

Whenever a situation like this arises and you think about giving it a try, just hold yourself back by thinking of the catastrophic losses that’ll you have to endure if your trade doesn’t go your way. The great thing about options is that you can make a lot of profit with little capital, but you need to remember that the opposite is also true, and within no time, you can lose out on your entire capital.

• Trade in Liquid Options

One of the most common mistakes that amateur options traders make is they risk their money on illiquid stocks. When it comes to options, there are a number of options that traders can choose from as the trades come with different price ranges and expiration dates.

To ensure you don’t find yourself in a situation where there are no buyers, trade options where the open interest is at least 5o times the number of contracts you are looking to trade.

These were a few things that you should keep in mind in options trading. As we mentioned earlier, trading options is a double-edged sword – the possibilities of making big profits and suffering huge losses are always there. With the help of a few strategies, you can trade options in an organized manner and minimize your losses.

Sarah Smith is the professional stock trader with 5 years of experience. Sarah also worked as a stock market trading trainer in Toronto.