Trading options can be exciting – at least it is when you’re making money. When you’re not, it’s a demoralizing experience that can shake your faith in your trading abilities. While you can’t guarantee success with your trades, you can give yourself the best chance of success by following a few key options trading tips.
1. Write Down Your Game Plan
The single-biggest problem for options traders, and traders in general, is trading based on emotions. When you follow your emotions, you’re not using sound judgment, which makes it more likely that you’ll make poor trades.
To avoid this, you need a game plan for how you’re going to trade. Write down the maximum amount that you’ll invest in any one trade, when you’ll take your profits and when you’ll cut your losses.
Keep this game plan with you and follow it to the letter. Don’t change it to fit your current mood. Traders lose money because they have no plan, so they’re constantly changing their approach. Also, consider an iron condor or butterfly spread.
2. Don’t Risk Too Much
Never put yourself in a position where one trade can make or break you, even if you’re sure you’re right. It’s wise to avoid putting more than 5 percent of your money in any single trade. If you’re just starting out, you may want to go even lower.
You won’t make as much on profitable investments, but when you follow this strategy, you would have to lose on 20 trades in a row to run out of money.
Another benefit of taking this approach is that it’s less likely for your emotions to enter the equation. It’s much easier to think logically about a trade when you’re only risking a small percentage of your money.
3. Buy and Sell Based on Value
The key factor in deciding whether to buy or sell an option is determining its value. Studying the stocks is important, but you also need to consider the price. The only way to make money with options trading is to buy options that are underpriced and sell options that are overpriced.
Identifying these options requires solid instincts for bargain hunting, which you develop as you trade more – another reason why it’s good to trade small, because you’ll have more opportunities to learn and get better.
4. Be Careful with Out of the Money Options
There’s a temptation among inexperienced options traders to buy options that are out of the money by a significant amount because of the low cost for a high possible reward. The odds that the contract will pay off are very low, so most of the time, you’ll be throwing your money away. Spend your time looking for smart trades that can make you money instead of trying to find a big winner.
The first thing you should do before making any options trades is figuring out your game plan. Once you’ve done that, look for options that provide a solid value and never risk too much on a single trade. Stay disciplined and you’ll see much better results than if you let your emotions get the best of you.