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What are some things everyone should know about options trading?

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  • What are some things everyone should know about options trading?

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  • #2
    Borrowed from Quora...







    Fundamentally understand that buying/selling options is all about making interest/volatility adjusted statements about the value of the underlying asset.

    Sell a put option - net premium - you think the stock is worth more than the exercise price. Sell a call option - net premium - you think the stock is worth less than the exercise price.

    Buy a put option - net premium - you think a stock is worth less than the exercise price. Buy a call option - net premium - you think a stock is worth more than that.

    You also think the adjustment will happen quickly - it rarely does. 90% of all options expire worthless.

    Buy put/call options to either a) hedge another position or b) take a flier at an event that you think is highly likely to occur within your time decay window.

    Otherwise - don't.

    Pricing options outside of the net premium value of the underlying is stupid.

    Selling cash secured put options is no different than having to buy the stock at the exercise price - net premium - so make sure you can cover your position and are happy to enter the stock at that price. I use them like more restrictive limit orders that pay me to buy stocks I'd like to have at the price I'd want to have months in the future.

    Options should never make up more than ~10% of your trading capital and all your positions should be fully cash backed without leverage such that you control the situation - not the market (assuming you think your positions are correct - it is irrelevant if your counterparty exercises).

    The only downside is that if you change your mind - limit orders cost nothing to cancel, but put options that go against and that you don't hold to expiry will cost you a lot. But if you're cash secured - you don't give a ****. Your also exposed to black swan events local to your company, industry, country, economy and global financial events - but that's the exact same as being long or having a limit order you can't cancel.

    Selling naked call options is stupid. Covered calls are much better, and allow you to take some of your gains off the table after a recent rise.

    The only thing that matters if you don't use margin, and make trades based on fundamental analysis - is that you think the stock is worth more or less (depending on your position) than the exercise - net premium. If you aren't happy with that - well than you shouldn't do the trade. Looking at things like vol/liquidity/spreads are useful to understand the market and see where things are out of statistical whack - but this is fundamentally what you are doing - taking positions on the underlying.

    Selling spreads, or doing overcomplicated option strategies is stupid because you'll get murdered by the complexity, derivative nature, multiple bid-ask spreads and the returns aren't that much better.

    Buying options is a losing preposition - don't try and be a Taleb - he makes more money on books and speeches.

    Selling unsecured options is a losing preposition - don't try to be an LTCM.

    Never use margin - neither with stocks or options. If you don't have the staying power to stay in the trade given anything less than World War 3 - you will be screwed eventually. Real traders understand that callable leverage is cheating and get their alpha from actually making better decisions than the market. Only wusses use callable leverage.

    Never expect that you can get out of a trade easily. I've seen too many guys sell options thinking - if this position goes against me - I can just get out. No you can't. Liquidity is always there. Until you need it. Don't expect it for stocks, don't expect it for bonds, don't expect it for options. I repeat you will not be able to exit your crappy trade. You'll always be able to exit your good ones.

    Option trades are taxed as income - so factor that in.

    Markets gap all the time - they are not continuous - get used to that assumption and stop looking at charts for the love of all that is capital.

    Volatility is a red herring and is another thing you cannot rely upon just like liquidity. Use it to your advantage - look at how the markets use it - but don't make your decisions using it - it's all about the underlying.

    Sell when the VIX is 20+. I've seen too many people who run out of trading ideas just sell options when the VIX is too low. Wait on your cash horde for a crisis and either buy the stocks outright, or sell puts/calls on them, and get them at a better price, or get paid to wait. Buying options during a crisis is expensive.

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