1. Understand the equity markets. Options are derivatives, meaning they derive their prices from the prices of the stocks, ETFs and indexes they are listed on. While options strategies can limit risk or even change the risk you take, you should have some sort of opinion of the general direction of the particular security you are trading. Additionally, it’s probably good if you previously traded in the equity market. Market mechanics also play a role in how the options markets behave. Know where and how your stock trades, its volume patterns and any relevant fundamental data. Be aware of upcoming economic data being released, as macro data may also impact your trades. Also important to note is that options have multipliers; one options contract represents the right/obligation to buy or sell 100 shares of the underlying. Additionally, an option’s price also has a multiple of 100, so an option priced at $1.50 will in actuality cost $150 in your account.
2. Know your broker’s platform, commissions, and important phone numbers. Before you even click the buy or sell button, make sure you know exactly how your broker’s platform works. This includes understanding all the different order types (market, limit, stop, trailing, target, all or none, fill or kill, etc.) It is very easy as a beginner and even as an experienced trader to make a simple mistake unrelated to the direction of the stock or the strategy you choose and put yourself in a pickle.
Hitting “buy” as opposed to “sell” and vice-versa is a common error, and using a market order in a fast-moving market (resulting in a disadvantageous fill) is another. There are a multitude of other common pitfalls. Practice entering spreads and make sure you get them right. OptionsHouse will let you know the total commissions before you enter the trade, which is a nice feature, but be sure you check breakpoints on commissions if your broker offers any.
The option chain is one tool that is extremely important to all option traders as it lists the strike prices and expiration dates of all available calls or puts for any particular security. An option chain also includes the most current prices paid for the calls and puts, as well as the daily changes in these prices. You should be able to access the option chains for the stocks in your portfolio via your brokerage platform or on websites specializing in option trading information. Note that option chains are only available on stocks, ETFs, and indexes on which options are traded.
Finally, it might be a good idea to write down your trades in a notebook along with your account numbers and the important phone numbers for your brokerage firm(s). In the event that your computer fails or your power goes out, you will be prepared. These are all real possibilities.
3. Know your strategy in and out and TEST it! OptionsHouse offers virtual trading and tools for you to simulate different stock and options strategies and experiment before you put your real money at work. One of the most common mistakes new traders make is to only look at the best-case scenario. When you are learning and testing a strategy, simulate what will happen if the stock and/or volatility and time move in your favor and what happens if these factors move against you. What would you do then? How will your strategy behave if volatility makes a large move in either direction? What happens if the stock goes nowhere for two months? Do you have an exit strategy in place other than taking profits?
Running simulations and understanding your strategy and its behavior in the real marketplace will not only increase your confidence, but it will allow you to set exit parameters more accurately. This also includes any technical data or patterns that you are looking at and specific trigger points on the charts that you will be using to enter and exit.
4. Be aware of key facts about your company’s fundamentals. While most of us are not certified financial analysts, those analysts who are accredited (as well as major publications and reputable websites) can offer us plenty of data when it comes to researching potential stocks to trade. Whatever parameters or financial data points you look at, make a checklist for yourself. Many professionals focus on the ability of a company to earn and grow its earnings over time. They also look at the ratio of a stock’s price compared to its earnings per share. This data point is only one of many, but you should have several fundamental points you check before entering a trade, bullish or bearish.