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5 Ugly Secrets They'll Never Tell You About Options Trading

Updated: Nov 6

Secret #3 will astonish you

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Introduction


Options trading can be a great way to make money in the stock market, but it's not a game for beginners. While there are plenty of online resources that will teach you how to trade options (and I encourage you to read up on how they work and how best to use them), there are some secrets that few people talk about:



Rule Number 1: Don’t do it.


Option trading is a very risky endeavor, and not for the faint of heart. While it can be highly lucrative for those who have done their homework, options trading requires a lot of time, effort, research and patience.


It also requires money, discipline and experience—and if all of those aren’t already in your toolbox you might want to consider investing elsewhere or at least getting some practice before trying your hand at options trading.


Rule Number 2: If you insist, start small.


If you're going to pursue options trading, then you should make sure that you do it right. To help ensure success, follow these rules:


Start small. If this is your first time trading options, don't start with a large amount of capital. Start by putting in only a few hundred dollars or so and learn the ropes before moving up to larger amounts.


Focus on one asset class at a time. When starting out with options trading, focus on just one asset class (such as stocks) until you get comfortable with how they work and how they react to different market conditions (like when interest rates change). Once you've mastered one asset type's strategies, then move onto another type of security or financial product such as bonds or currencies.* Set a maximum loss amount for each trade*.


As part of setting up the parameters for each option trade that we enter into our portfolio management system (more on this later), we will always have an automatically calculated maximum loss per contract based upon various factors such as strike price versus stock price movement during expiration period plus commission costs associated with buying/selling shares through brokers/dealers; however if someone doesn't want us managing their portfolio then there should still be some sort of limit placed upon losses.* Use a demo account


Rule Number 3: Don’t risk more than 2% of your account size per trade.


Risking more than 2% of your account on any one trade is a surefire way to lose money. This rule of thumb is applicable across the board, and it's especially important for new options traders. For example:


If you have a $10,000 account, don't risk more than $200 per trade!


If you have a $50,000 account? Don't risk more than $1,000 per trade!


And if you have an even bigger account? Maybe consider trading with only 1 contract at a time (which would mean risking no more than 2%).


Rule Number 4: Always take the underlying into account when creating an options strategy.


There are two types of factors that you should always take into account when creating your options strategy: the underlying price and its volatility.


The underlying price is the most important factor because it dictates how far an option can move. As an example, if you buy a call option on 100 shares of Apple stock at $250 per share, the maximum profit potential would be $250 times 100 shares or $25,000 ($25,000). If Apple stock goes all the way up to $500 per share (a 100% increase), then your profit potential becomes twice as large ($50,000).


However, even though this is a great outcome for an investor who bought calls on Apple stock at $250 and now wants to sell them off at twice as high a price ($500), not all options go up in value when their underlying moves higher—and this leads us straight into our next point: volatility!


Rule Number 5: Never chase a dead trade.


Now that we’ve talked about the different types of options trades and their best uses, let me reiterate an important point.


Always be sure to have a plan before you start trading options. Trading without a plan can lead to bad habits and costly mistakes, so always make sure that you have an objective when entering into any trade.


The last thing I want anyone to think about is chasing dead trades or trying to get back money lost on an option trade by doubling down or increasing their position by more than 50%.


Rule Number 6: Always set your boundaries and stick to them.


Always set your boundaries and stick to them.


Know how much you're willing to risk on a trade. Once you've determined that amount, add another 10% as a cushion for unexpected losses and commissions.


Know when to cut your losses. If the market moves against your position, be prepared to close out early at the first sign of trouble. Don't get greedy or let one bad trade ruin an otherwise positive day—there are plenty more opportunities out there; don't waste time on ones that aren't working out!


Know when to take profits off the table as well—even if they're small! The longer they stay in play, the greater chance they'll turn into losses (or worse: become huge gains).


If this sounds like too much stress for your liking... It shouldn't be! You can actually walk away from trading when things get tough by taking a break from trading altogether instead of trying harder at something that isn't working right now (i..e., looking for another option strategy).

This will allow yourself some time off without feeling guilty about leaving money "on the table" because hey -- maybe after some rest those trades will make sense again :)


Rule Number 7: Avoid profitless trades.


You've probably heard this before, but it bears repeating. You should avoid profitless trades.


This is where you enter a trade with the hope that your stock will move higher in value, without any real evidence to support your assumption.


For example, if you're buying a call option on stock ABC at $10 and its current price is $9, then you're making an assumption that ABC will move up in price by more than 1% before expiration date. However, there's no guarantee or even likelihood of this happening—and if it does happen, it might only go up by 0.5% over three months instead of 1%. If you don't have reasonable expectations for how much profit potential there is in your trade, then don't take it!


It's important to note here that often times when investors say they'll "just let their investments run," they actually mean they're hoping for their investments to make money without doing any work themselves besides occasionally checking their account balance online once every few weeks (or months).


We've all been guilty of this at one point or another; however, now that we know better we should actively avoid doing so moving forward!


Rule Number 8: Avoid short expiries..


Short expiries are a bad idea for two reasons. First, they make it harder to get out of a trade before the expiration date. You'll have to deal with closing costs and commissions (see Rule Number 7 for more information about this). Second, short expiries provide less time for your options' price to move in your favor.


So if you're looking at an options trade where you don't think anything will happen until near expiration, consider extending your timeline instead of trading shorter-dated options contracts that expire within days or even hours - it could save you money!


Rule Number 9: Avoid buying options at prices that exceed the vast majority of past prices for the same security, expiry, and strike price.


This rule is a good starting point for understanding what to avoid when buying options. The vast majority of past prices cannot be used as a guide because they often reflect extreme volatility and other factors that are not applicable at the time you are making a trade.


The following example shows how to use this:


Let's say you want to buy an option on Apple that expires in one month, but your broker only shows prices in increments of $1 (U$0.25). If we look closely at the data, we notice that most of the option prices have been between U$0.25 and U$0.75 with very few instances where they were over U$1 (i.e., above 1 standard deviation from the mean). In other words, if we see an option priced at $2 or more then it should probably be avoided since it would violate Rule Number 9!


Rule Number 10: Be very wary of trading psychologically vulnerable stocks in bear markets.


As you read this, you may be wondering how to determine whether or not a stock is psychologically vulnerable. There are many ways to do so, and I will discuss them in depth in future articles. But for now, let's just say that if there is any doubt at all about the health of your psyche while considering a particular trade (or series of trades), don't do it! This is especially true if you've had a string of losing days or weeks, or if there has been some kind of major event that has shaken up your world.


It's easy enough to identify psychologically vulnerable stocks when things are going well: You'll know because they'll look like great buys with good charts and strong fundamentals—but by then it might be too late for them as well as yourself!


If we're going to put ourselves through hell every time we make an investment decision, then we might as well aim for something more than being right half the time. It's no wonder so many people come away from financial markets disappointed by their results; they often aren't willing to take adequate measures beforehand against those inevitable losses!


Options trading, done right, can enhance profits in all kinds of stocks, but is best employed in stocks that are moving easily and steadily up or down in price without much hesitation or volatility


Options trading, done right, can enhance profits in all kinds of stocks. But this method is best employed in stocks that are moving easily and steadily up or down in price without much hesitation or volatility.



Conclusion


As you can see, options trading is a great way to make money, but it’s not for everyone. If you’re interested in options trading and want to learn more about how it works and the risks involved, we recommend our SuperBearish Course which is 100% free as a trustworthy source.


Get started today with Options trading and join our Premium community where you will get access to 3 alerts daily as well as access to multiple other platforms we provide for our premium community.

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