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10 Incredible Tips to Know Before Options Trading

These tips have saved my ass through out the years I can say that

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Introduction


The past few years have been tough for the stock market, but that doesn't mean options traders haven't done well. In fact, many options traders have thrived as a result of the recession and its aftermath. If you're new to options trading or want to improve your skills as an existing trader, read on to learn how you can use this unique time in history to become more successful.


Think, like a poker player.


Poker players have many qualities that make them effective traders, including:


A knack for thinking about odds and risk. Poker is a game of probabilities, and poker players are very good at calculating their chances of success or failure in a given situation.


A sense of human psychology. Poker players know that they can’t always win by playing strictly by the book; sometimes it’s more important to be aware of your opponents than it is to stick to your strategy.


Awareness about themselves as players. If you want to be successful at poker, you have to know your own strengths and weaknesses—and keep working on improving them!


Be aware of deltas.


To be aware of deltas is to know how much an option's price will change relative to the price movement of the underlying stock. Deltas are a measure of how fast an option will change in price and how closely its price moves to that of the underlying stock.


For example, if you were looking at two options that had different deltas and were trading at $2.00, you might buy the option with a delta value of 0.60 because it could move more than twice as quickly as its counterpart, whose delta value is only 0.30 (0.60 > 0.30).


Find the right tradeoffs.


The best way to understand tradeoffs is that they are the price of options.


The cost of an option contract is the price you pay for the right, but not obligation to exercise your options contract at any time during its life.


If you make a tradeoff, it means that you are willing to accept some risk (the probability) in exchange for some reward if all goes well and/or potential loss if something goes wrong.


Gearing up could be risky.


Gearing up could be risky. You know, gearing up? When you borrow money to buy stocks. If your stock goes down, you'll have to pay back more than what it's worth and that can be really painful. And if your stock goes up, well then again it will be painful because now you have to pay back less than what they're worth and that's called having a negative cash-flow situation which we all know is bad news for investors who don't want their capital tied up in one place for too long!


And finally there's interest rates: if those go up then borrowing becomes even more expensive which makes buying stocks with leverage even riskier...


Don't stubbornly buy your favorite stocks.


The second mistake is not to buy stocks you like just because they are your favorite. It’s important to understand the risk-reward of the trade before committing capital. If a stock is down 50% and you believe it will recover, then by all means go for it, but don’t be stubborn about buying a stock just because it was your favorite at one time or another.


Thirdly, don’t buy stocks just because they are the stocks you know best. This can lead to overconfidence and poor judgment as well as poor performance on trades that have little upside potential but significant downside risk.


Take advantage of unprofitability in option writing.


If you're an options trader, you can make money by writing options.


But you need to be careful. The biggest risk that option writers face is the possibility of bankruptcy if their positions were to be "called" and they were unable to cover their losses from having written too many contracts. This is what happened in 2008 when Lehman Brothers collapsed, causing widespread devastation for all kinds of financial institutions.


There are other risks as well -- for example, if you write an option at one strike price and then see the underlying security fall below that level before expiration date arrives (meaning you lose money), this would be a problem as well!


Furthermore, it's important not to forget about implied volatility when writing options -- if implied volatility increases after your trade has been initiated but before expiration arrives (meaning buyers pay more than they previously did), then this could mean trouble too...



Diversify with ETFs, not individual stocks.


If you’re looking to diversify your stock portfolio and manage risk, there are a number of ways to do this. One option is to use Exchange-Traded Funds (ETFs) instead of individual stocks. ETFs are similar to mutual funds in that they hold stock (or other types of investments) and they trade like stocks on the market. They have several advantages over mutual funds as well:


ETFs are more liquid than individual stocks because there’s always an active market for them, so if you need to sell quickly, it will be easier with an ETF than an individual stock.


They’re cheaper than buying individual stocks because there aren’t any fees associated with owning an ETF like there would be if you bought shares directly from a company like Apple or Alphabet (Google).


They’re more tax efficient because when you buy shares through an exchange-traded product like this one here called "SPDR Dow Jones Industrial Average ETF", all profits from selling those shares go into something called “capital gains accounts" which are taxed at a lower rate than normal income taxes; whereas if I were just trading my own stocks then typically I'd owe capital gains tax which is much higher than regular income taxes!


Another way that these things can help me save money is by avoiding unnecessary spending on things such as brokerage commissions - which could add up fast over time!


Narrow down on quality stocks with great options.


You: "Wait, I'm not sure where to begin. How do I narrow down the list of stocks to choose from?"


Them: "Well, first you want to look for stocks with high implied volatility."


You: "What's that?"


Them: "It's basically how much the options are expected to move up or down in value. The higher the IV, the more investors believe there will be large swings in price movement."


Look for a stock that's beaten down but has come to life recently.


I recommend looking for a stock that's beaten down but has come to life recently. If you can't find one, try looking for stocks with great options. At the very least, make sure the stock is currently profitable and that its option prices are attractive by checking them out on StockTicker


Think about the market for other economies too.


You may be a US citizen, or you may live in the US. But that doesn't mean that the US is the only economy, country and market out there. And it certainly doesn't mean that everything that happens in the US has to affect you or your trading strategy.


If you're an options trader who's been watching your assets get crushed over the last few weeks (or months), take some time to think about how other countries' economies are doing as well—and what impact this might have on their markets and currency exchange rates.


  • Options traders need to focus sharply on their risk and also look for opportunities in new ways during a recession


  • Focus sharply on your risk and look for opportunities in new ways


  • Think like a poker player


  • Be aware of deltas


Mike Tyson (the boxer, not the former Governor of Minnesota) once said: “Everyone has a plan until they get punched in the face.” In other words, things can change very quickly and without warning. Don’t get caught off guard by sudden changes in market conditions; make sure you are prepared for anything that might happen.


Your trading plan should include contingencies for adverse scenarios so that even if something unexpected comes along, your portfolio will be protected and ready to take advantage when things turn around again.


Another lesson from poker is never to show an opponent how strong or weak you are unless it's necessary at that moment--and even then only do so if it is advantageous! Similarly, don't tell anyone else how well or poorly things are going with your options trading account right away--it's none of their business anyway!


Remember: In both poker and options trading there are winners and losers; some people lose money while others make money…and sometimes those who lose one round win back their losses later on--so don't assume either outcome beforehand!


Conclusion


In the end, options trading is a game of risk management and finding opportunities in new ways. It also shows that you need to be aware of how the market is changing as it goes through its ups and downs.


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