Securities traders have various financial instruments to choose from, each catering to different investment needs. Among these options,  options trading is both exciting and complex. Though the dynamics of options trading can initially seem daunting to novices, mastering its techniques and strategies can lead to solid financial gain.

While some have already mastered the art of options trading, many are still exploring this intricate field. To help beginners navigate this journey, we present five essential tips for successfully entering the world of options trading.

Clarity of Basics, a Non-Negotiable Deal

Before entering any new domain, it is essential to understand the fundamentals of the field. Similarly, before understanding the nuances of options trading, it is essential to understand precisely “Options” and the technical jargon related to it. Options are financial instruments, a derivative instrument to be precise, that give the holder of the option a right, but not an obligation, to buy or sell an underlying asset at a pre-determined price on or before a pre-determined future date.

The two most famous kinds of Options are American Options and European Options. American Options gives the option holder the right to exercise the option at any time before the expiration date. In contrast, European Options give the option holder the right to exercise the option only at the expiration date.

Some more basic concepts to be kept in mind:

Call Option – This option gives the option holder the right to buy the underlying asset.

Put Option- This option gives the option holder the right to sell the underlying asset.

Spot Price– The market price on the date when a person enters into an options contract

Strike Price– The pre-determined price at which the underlying asset can be brought and sold at a future date.

Expiration Date – The date on which the options contract would lapse.

Options Premium– The amount paid for the option.

While these seem overwhelming initially, once a beginner gets familiar with these concepts, it helps them further with strategy-making and decision implementation.

Strategies to Be Put into Action While Trading

It is always better to keep things simple at the start. When it comes to options trading, one specific feature that sets it apart from other types of trading is the varied strategies that can be implemented. Beginners can start with two of the most famous and basic strategies to get a grip on them before proceeding to complex strategies.

• Covered Call: In a covered call, a long position is held in stock while a call option is sold on the same stock, generating income from the sale. This strategy works best when a little to moderate increase in the stock price is anticipated. While the risk is limited to the difference between the stock purchase price and the strike price adjusted for the premium received, the reward also stays limited to the premium received by the sale of the call option plus any profits up to the strike price.
• Protective Put: A protective put strategy involves holding a long position in a stock and buying a put option for it. It is best implemented when a decline in the stock price is expected. While the risk is limited to the premium spent on the put option, the reward is unlimited if the stock price goes up, adjusted for the premium.

While there are numerous strategies, such as Straddle, Strangle, Broken Butterfly, Married Call, etc., beginners should always start with the most basic strategies to understand the nuances of the market.

Get familiar with the Greeks

Options traders consider Greeks when making any informed decisions about their trade. Greeks refer to a varied set of calculations that shows the impact of different factors on the options contract price. There are 5 Greeks that should be set in the minds of an options trader as these are the pre-requisites to be considered before executing any options trade :

Delta helps one gauge the likelihood that an option will expire with its strike price below (for calls) or above (for puts) the underlying stock’s market price.

Gamma helps one estimate the effect on Delta with a change in the stock’s market price.

Theta helps one measure how much value an option loses day by day while approaching the expiration date.

Vega helps one understand the sensitivity of an option to large price swings of the underlying asset.

Rho helps one simulate the effect of changes in the interest rates on the options.

Risk Management and Diversification are Your Friends in Need

While options trading is a very lucrative trading mechanism, it comes with many hidden and exposed risks, which, if not managed properly, can prove critical. Effective risk management ensures that capital is protected and also leads to long-term gains :

Position sizing is vital for any trade, specifically in options where volume has a more significant role to play. One should appropriately determine the size of each trade based on portfolio size, risk appetite, and risk tolerance. Usually, one should not risk more than 2% of their portfolio on a single trade.

Stop Losses are a savior even in Options Trading. While traders expect profits to be unlimited, it is always prudent to limit losses that can be borne.

As the old saying goes, “Do not put all your eggs in one basket.” It is always advised that one avoid putting one's money into one specific type of options. One should diversify based on the industry sector, the underlying assets, expiration dates, etc. Diversification will let the trader explore different angles of options trading and help mitigate risks.

Leveraging is a good technique for options trading. Still, too much of anything is bad, so options traders, specifically beginners, should avoid over-leveraging to avoid losses.

Learning is A Continuous Process

While one can feel after a couple of months of trading that they have gotten a hold of how everything works, they would ignore that feeling. Even veteran options traders educate themselves continuously as everyday innovations are happening in the market, changing how each financial instrument works and integrates into the whole trading system. Beginners should continue learning new techniques, use trading simulators, keep track of financial happenings, and, if required, should also seek professional guidance.

While options trading is one of the most lucrative forms of trading when it comes to profits, the challenges that come with it cannot be ignored. Properly implementing strategies, understanding the underlying concepts, and leveraging them while trading can help beginners get comfortable with the market and execute trades effectively. Along with all these, persistence, options trading resources, constant practice, patience, and commitment are indispensable in Options trading. By following the right track, a novice could become a seasoned options trader quickly.

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