Getting started with options trading

Before you get started with options trading, you should do a lot of research so that you understand what options are all about.

I have discovered in blogs that people did not understand what they were getting involved with until they had committed money.

The risk of loss in trading securities, options, futures and forex can be substantial. Investors must consider all relevant risk factors including their own personal financial situation before trading. Options involve risk and are not suitable for all investors.

 

Regardless of how aggressive an investor you are, you probably shouldn't commit more than 5% of your invested funds with options.  You should also have enough bank so that you can make 20 trades with the same amount of capital committed to each trade.

Let's say you are going to commit $10,000 to options trading, then you should plan on only putting down $500.00 per trade until you build your balance up.  You can (read WILL) come across a streak of bad trades and if you commit too large a share of your options money, then you could get wiped out.

$500.00 on an option trade is probably the smallest amount you want to commit to a trade.  Smaller dollar amounts means your transaction costs, on a percentage basis, will be very high and it will make it that much more difficult to make money.

A fellow subscriber to one of the option services once mentioned that they only committed $100.00 to an option recommendation because they weren't sure about the advice. You either commit or don't commit, there is no reason to put in a measly hundred on a trade.

Here's why: Let's say the option they bought was trading at $1.  That one contract cost them $100.00 (1 contract represents 100 shares at $1.00), but let's not forget the commission.  That person told me they bought it from one of the online discount brokers (this is the only way to go with option trading, do not use a Smith Barney type or it will be near impossible to make money on option trading due to their high fees) at a cost of $20.99.  Don't forget that the goal is to make money and that means you want to sell at a better price than what you paid which means you incur another what? Yes, another commission must be paid.  In this case that person would have to pay another $20.99 to get out. $21.00 doesn't seem like much in fees, but when you figure it on a percentage basis, then you see why you should commit more or stay on the sidelines.

This means they would need that option they bought for $1.00 to appreciate 42% just to break even. Folks, options do appreciate better than 42%, but you are stacking the deck against you.

A better way to act on the information is to either 1. Pass on it. I found it is not always a good idea. It seemed that the ones I passed on were truly big money winners. 2. Commit your predetermined equal stash. In the above example, had you purchased 10 contracts, then you would need the option to go up 6% for you to break even.  They were paying $19.99 for the transaction plus $1.00 per contract, $29.99 to buy and another $29.99 to sell.

Let's say the option went up to $2.00 a contract, then the person that committed $100.00 would net $58.02 or 58% on a 100% move after transaction costs.  The person that committed $1,000.00 (continued)

 

 

 

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