Top 10 Option Trading Tips

Option Trading Tips

Option Trading Tip #1

My top 10 call and put option trading tips that I have learned, and that you MUST know before you start trading calls and puts.

Trading Options Tip #1:

A stock price can move in 3 directions:

  • It can go up
  • it can go down, and
  • it can stay the same.

Most beginning option traders think that stock prices will either go up or go down, but they would be wrong! There is a third direction that stock prices move that is extremely important for call and put traders. Option traders must remember that that sometimes stock prices don't move up or down at all and that they can stay the same or remain in a narrow trading range.

Look at the chart below and you will see that for the last 23 days this stock's price remained mostly unchanged. Had you bought call options (expecting a bounce) or put options (expecting the continued decline) you probably would have lost your money!

option trading tip stock price moves in 3 directions

So don't think you have a 50% chance of making a profit when you buy a call or a put option. It's more like 33%. That's because if stock price movements are random you will find that 1/3 of the time the stock price goes down, 1/3 of the time the stock price goes up, and 1/3 of the time the stock price remain flat or stays almost unchanged. In fact, when you are long a call or put option, time is your worst enemy. Each day that goes by your option is losing value since the chance that the stock price will move in the direction you want it to move is diminishing.

When you buy a call option, you are betting the stock price will go up. Sometimes the price will go up and you will have a profitable trade. But sometimes the price goes down, and sometimes the price just stays the same. If the price goes down or just stays the same and you bought an out-of-the-money call, then your option will expire worthless and you lose all of your money. If the price just stays the same and you bought an in-the-money call, then you will at least get your intrinsic value (or your in-the-money amount) back.

Sometimes the most frustrating thing about buying call call option is watching the stock price sky rocket the week after your option expired. In this case you will learn that you didn't give your strategy enough time. I have bought many call options that expire in the current month, only to see my stock stay flat and then rocket up AFTER my call option expired. That's the risk that you take buying a near month option and not a longer term option. That's also the reason the longer the term of the option the more costly the option will be.

Because of this concept that stock prices move in 3 directions, it supports the general claim that 70% of option traders that are long call and put options lose money. This means that 70% of option sellers make money. This is what drives a lot of the more conservative option traders from the strategy of buying call and put options to selling or writing covered calls and puts. Keep reading my next tip that you must study a stock's chart before buying call or put options.

Options Trading

Options Resources and Links

Options trade on the Chicago Board of Options Exchange and the prices are reported by the Option Pricing Reporting Authority (OPRA):