By: Steve Smith
With the recent surge in new retail trading accounts, much of which has focused on highly speculative names and aggressive day trading activity, we’ve seen a concurrent increase in interest for stock option contracts by small traders looking for a jackpot. When people talk about options trading, the conversation often turns to ultra-risky strategies like buying way out-of-the-money call or put options, which have a low cost in dollar terms and can deliver big returns. But like the lottery tickets they are often compared to, they also have a very low probability of success and often result in 100% loss of the money ‘invested.’
On the other hand, some people stay, or are scared away from options because they feel the options strategies are too complex; names such as butterfly spread and iron condor can be intimidating to newcomers. The truth lies in between; when used correctly options can be used to both enhanced returns and reduce risk.
And the best part is it only takes a few basic options strategies to fully arm yourself with a flexible arsenal to capitalize in all market conditions. It starts with education. If the meanings of the words and terms at the top of this article, such as “put” “call” or “out-of-the-money” are unfamiliar to you, that means you need to get some basic training before putting your hard-earned money in the options table. The internet, of course, is an endless source of such education information. One of my favorite sites is TastyTrade Learning Center which has an incredible library of articles and videos. It will provide beginners with basic definitions and then introduce concepts such as the Greeks and implied volatility and finally leads towards applicable options strategies.
People are drawn to options because of the combination of power and finesse. That is, they can offer leverage which will magnify gains (and losses) and also can help fine-tune a stock-only investment approach. But like a job you need to pick the right tool for the job you’re trying to accomplish. That means you don’t use a sledgehammer to fix a wristwatch.
There have been growing complaints that some brokerage platforms, namely Robinhood, are allowing new traders access to options trading without the proper experience or warnings of the risk. Most brokers do require cursory knowledge and will require filling out a form and answering a short questionnaire. But to my mind, it really is one’s own responsibility to make sure they are educated and understand not just the concepts and mechanics of options trading but have also seen how it works in real-time.
For my part, I was lucky enough to work as a market maker on the floor of the “Chicago Board of Options (CBOE)” at a young age acting as a commissioned broker. That is I was simply executing orders for a firm without risking my own money.
It was a full year before I made my first personal trade. And despite my patience, that turned into a disaster. Nowadays, most brokers offer virtual or paper trading accounts in which you can practice entering orders and trying different options strategies without any monetary risk. My suggestion would be use these paper accounts along with the educational resources as your first steps towards beginning to trade options.
Click here to find out more about Steve Smith’s unique and successful approach to options trading.
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.