Options Trading FAQ
Here are a few resources besides our Options Trading FAQ that you can look at to answer your options trading questions:
Option Trading Rules (examples of the kinds of rules you should have, and more importantly you should follow)
Option Trading Glossary (just in case you don't understand the terminology)
Option Trading Mistakes (you know, those things all of us won't admit that we make when we first start out trading, and sometimes for years well beyond that.)
Options Trading FAQ Categories
- Options Trading FAQ General Information- Options Assignment, Exercise, and Expiration FAQ
- Option Software and Web Sites FAQ
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Additional Options Trading Resources FAQ
General Information Options Trading FAQ
Q: Why trade options?A: OK, we must admit that trading options is more exciting than trading just individual stocks or commodity futures contracts. Unlike stocks, however, options can provide an investor the financial benefits of leverage over a position in an individual stock or a basket of stocks reflecting a broad market index. While that may sound risky, used properly, investors can use options to limit their risk, and increase their rate of return, when compared to an outright position in a stock, index, or futures contract.
Where you must be careful is when you are selling options. Writing an option without having some type of hedge is often suitably referred to as being naked. That is because option writers assume significant risk if they do not hedge their positions. So NEVER leave yourself naked (especially in the winter) when trading options.
OK, now lets give you a few good reason to trade options:
1. Options offer protection from a decline in the market price of a long underlying stock, commodity, or a portfolio of stocks.
2. Options enable you to buy a stock at a lower price by exercising an in-the-money (ITM) call option.
3. Options enable you to sell a stock at a higher price by exercising an in-the-money (ITM) put option.
4. Options can be combined to create options strategies that offer limited risk approaches to taking advantage of bullish, bearish, and sideways markets.
Q: What should I consider before I start trading options?
A: While options can enhance your overall portfolio returns, there are several things to consider before trading or investing in options.
- The most important thing to remember is DO NOT trade options with money you cannot afford to lose, period.
- Make sure you have enough cash on hand for emergencies.
- Invest fully in your 401k plan. Make sure your 401k portfolio is well diversified.
- Invest fully in a Roth IRA or a Regular IRA. Make sure each of these portfolios is well diversified. Some brokers will allow you to trade options in your IRA accounts. Limit your options exposure to no more than 5 - 10 % of your account.
- Have a well diversified asset allocation in your brokerage account before you begin trading options. Look at web sites like Insightful Investing to get a handle on this. Use no more than 10% of your investable assets for trading. Consider opening a new account just for options trading.
Q: How do I get started trading options?
A: First, you will want to educate yourself on option basics, understand what calls and puts are as well as the rights and obligations of buyers and sellers. You can then determine if options are suitable for your portfolio. If you feel options are suitable, you will apply for approval to trade options with a brokerage firm by completing an application. If you don’t feel that options are suitable for you, do not pass go, do not collect $200, but do move on to another web site because reading all of this stuff will be a waste of your time, but we digress. The options application is in addition to your standard brokerage application. It will probably ask you to disclose the types of option strategies you would like to employ, your financial profile, risk tolerance, experience with options trading along with other information. There are various levels of options trading which you can request. Your approval level will be based on your brokerage firm’s assessment of risk they are willing to accept on your behalf and your knowledge of options. When you are approved for options trading, you are ready to begin entering opening trades.
Q: How do I find a broker?
A: The best way to find a broker is to talk with your friends, or find an options trading group, and ask them whom they are using. Look at the Brokers section of our web site for a review of brokers that specialize in options. While you may be able to trade options with your current broker, you may find that you have a lot of restrictions on your trading because your broker isn’t really an “options” broker. In that case we suggest that you establish a separate account just for options trading with another broker.
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