Options are considered as one of the riskiest financial products you can trade. Doing it without any prior risk management, the right methodology or technical approach, and market experience can expose your capital to a dangerous level. Here are four signs that indicate your readiness to trade options.
You Can Manage Risk
Risk management is perhaps the most important principle in any trading endeavor. This encompasses your ability to foresee actual dollar risk/gain per trade, decide on correct position size, identify signals to exit a trade and close a trade when the situation calls for it. There are psychological barriers at play when trading stocks, or any financial product for that matter. Greed and hope may prevent you from exiting a trade when all technical and fundamental indicators are telling you to do so. Good risk management includes the self-control to actually follow through with your plan, regardless of the outcome.
You Understand What Time Decay Is
Time decay is one of the key differentiating qualities of options trading versus stock trading. Time decay measures the rate of value decline in a contract over time. All options contracts have an expiration date. The closer the contract is to its expiration date, the less valuable that contract becomes. Time decay is also displayed as Theta in many broker platforms and investment tools.
You Understand the Four Different Contracts You Can Trade
In options trading, there are four main contracts you can execute – buy a call option, sell a call option, buy a put option, and short a put option. Buying a call option and selling a put option are both bullish strategies for when an investor is betting on the underlying stock to increase in value. Meanwhile, selling a call option and buying a put option are both bearish strategies. Knowing the differences between these four contract types is key to positioning yourself profitably in the market.
You Have Enough Capital
Options contracts can be more expensive than the underlying stock that it mirrors. For instance, TSLA, which costs around $1,500 per share, can have a call options contract that costs at least ten times that. Having enough capital is important if you want to be able to buy contracts without financial restrictions.
To help you prepare for options trading, open a demo account, and trade with fake money first. Give it at least six months and see how you perform. This gives you a firsthand experience on how options trading works without exposing you to real losses.