If you are going to try your hand in option trading, then remember these 7 things of expert

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Options trading is a lot like diving into the ocean. It is very risky without proper training and precautions. However, a whole new world opens up if one dives deeper with the right training, tools and precautions. Options can provide greater exposure to stocks and indices in a variety of ways, but just like diving in, it’s important to arm yourself with the right knowledge and risk appetite before diving in.

Opening doors to big bucks

Today we’ll take a look at seven things everyone should learn before venturing into options trading. Following these rules can improve your decision making process and pave the way for you to maximize your profits while reducing your risk.

Know these things before trading options

Decide the objective: Before any trade, it is important to have a clear objective of your investment. What are you trying to achieve with that particular option trading? Whether to speculate based on your bullish or bearish outlook on the underlying asset? Or are you using the trade to hedge (protect) the potential downside risk of a stock you hold? Defining your objective will help you choose the right options strategy and align your trading with your overall financial goals.

Consider the risk-reward payoff: Determining risk-reward is an important aspect of options trading. It depends on understanding your individual risk appetite as a trader. If you are a conservative trader, then strategies like selling naked options may not suit your goals. Instead, look for option strategies that offer a clear, pre-defined risk-reward structure. It is important to note that with high reward usually comes high risk. It is important to find the right balance between your risk appetite and your investment objectives.

Check Volatility and Events: Volatility plays an important role in option pricing. Check the current market volatility and any future events or news that may have an impact on the underlying asset. High volatility may mean that you will pay a higher premium for the option, which may have an impact on your trading strategy and potential rewards.

Create a strategy: Create a clear options strategy based on analysis, risk-profile etc. Consider the options strategies available, such as buying calls or puts, and applying the spread. Each strategy has its own risk and reward profile, so choose the strategy that best suits your goals and risk appetite.

Check Bid-Ask Spread: Traders should always check the Bid-Ask Spread before entering a trade. Bid-Ask is the price the buyer is willing to pay and Ask is the price at which the seller is willing to sell the asset. The spread is the difference between the bid and ask price. In some strike prices or illiquid stocks, there is a wide difference between the bid and ask prices. Sometimes traders just look at what was the last trading price and ignore the bid-ask spread.

Avoid buying distant options:  The lure of buying options cheap often leads traders to strike a strike that is far away from the current price of the underlying value. This approach can result in potential losses, as the underlying asset would need to grow significantly before expiry for these options to be profitable.

Trade with a stop loss: Once you have locked your trade, consider placing a stop-loss order to protect yourself from further losses. If the stop-loss order reaches a certain price level, your option contract gets finalized automatically. This helps limit potential losses if the trade goes against you.

Note, options are very complex financial instruments. Make sure you have the basics down before trading options. Success in options trading requires thorough planning and a systematic approach. By following these seven key steps, you can improve your decision making process and increase your chances of winning trades.

Disclaimer – Writer Puneet Maheshwari is the director of UpsTalks. The views published are his personal. Before investing in the stock market, take the advice of your financial advisor.

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