{"id":187694,"date":"2023-03-31T11:30:00","date_gmt":"2023-03-31T15:30:00","guid":{"rendered":"https:\/\/ibkrcampus.com\/?p=187694"},"modified":"2023-03-31T10:49:22","modified_gmt":"2023-03-31T14:49:22","slug":"how-to-get-started-trading-options","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/traders-insight\/securities\/options\/how-to-get-started-trading-options\/","title":{"rendered":"How to Get Started Trading Options"},"content":{"rendered":"\n

Starting anything new is difficult. That\u2019s the truth, and more often than not, articles addressing \u201cHow to Start (________) \u201c like a diet, running, investing or a new language will oversimplify the process.<\/p>\n\n\n\n

Humans are creatures of habit. In general, those habits serve us well. We are the products of evolutionary biology. However, establishing a strong foundation for a novel endeavor is far less natural.<\/p>\n\n\n\n

The other issue is that many of the \u201cexperts\u201d that write about the basics of using options have managed options risk for so long that they struggle to communicate in terms that resonate with a novice. Far too frequently, they are afflicted with The Curse of Knowledge<\/a>.<\/p>\n\n\n\n

So here are a couple of things to keep in mind before you start trading options. <\/p>\n\n\n\n

Trust You<\/strong><\/h2>\n\n\n\n

From my standpoint, when discussing financial matters, there is no \u201cright way\u201d because our circumstances are entirely unique. Despite the varied backgrounds, there are \u201cbetter ways\u201d to begin incorporating options in your portfolio.<\/p>\n\n\n\n

First and foremost, use only discretionary capital<\/u><\/strong>. That axiom applies across financial disciplines. You must have your basic needs met before allocating funds to investments of any sort.<\/p>\n\n\n\n

Then manage your expectations and establish a plan.<\/p>\n\n\n\n

Many people want to skip this step, but it\u2019s critical. Starting anything new involves a process of learning, feedback, and refinement. It\u2019s also important to set realistic targets. Absent this, the approach is likely to fail.<\/p>\n\n\n\n

Think about \u201cNew Year\u2019s Resolutions.\u201d According to research<\/a>, about 80% of people \u201close their resolve\u201d with resolutions by mid-February. In general, we \u201cfail\u201d because there is inevitable friction, and we set the target too high.<\/p>\n\n\n\n

It\u2019s a Marathon, Not a Sprint<\/strong><\/h2>\n\n\n\n

Using a personal example, I\u2019ve been an active runner for years. I\u2019ve finished several half-marathons, and when I\u2019m in shape (read: sticking to my plan and incrementally improving), I can run a long way at an 8-minute-per-mile pace. Not too bad for a guy in his mid-40s.<\/p>\n\n\n\n

Lately, it\u2019s been more difficult for me to run regularly. I live just outside Chicago, and it\u2019s cold (I don\u2019t like running on a treadmill). Plus, I have a very active 8-year-old son. Yesterday was warm, and I had some free time, so I went on a short run. I didn\u2019t target any pace. I got in about 2 miles and called it quits.<\/p>\n\n\n\n

Many people in my situation will try to get right back to running a 10k (~6 miles). They will run too far or too hard in the beginning and may strain muscles.<\/p>\n\n\n\n

In my estimation, financial well-being is akin to physical well-being. The process is very similar. You need to establish a base and try to improve incrementally. Sometimes you must go back to the basics. Putting one foot in front of the other, if you\u2019ll pardon the pun.<\/p>\n\n\n\n

Ignore Noise<\/strong><\/h2>\n\n\n\n

Bringing it back to options, perhaps you\u2019ve seen someone on social media touting their success trading derivatives. For example, there was coverage of a sizeable index options trade ahead of the Consumer Price Index (CPI) data. This situation involved an index option that expired the same day (0 DTE). The call option was out-of-the-money (OTM) in the early afternoon and traded for $0.35. By the end of the day, that option was worth ~$25.00 because the Nasdaq-100 Index (NDX)<\/a> and S&P 500 Index (SPX) rallied hard into the close.<\/p>\n\n\n\n

\"For<\/figure>\n\n\n\n

Source: LIVEVOL PRO<\/p>\n\n\n\n

These narratives feed our FOMO (loss aversion) heuristic. There\u2019s a natural desire to take the \u201ceasy route.\u201d We tell ourselves, \u201cSomebody risked $35\/option, and a few hours later, each option was worth $2500. I can do that!\u201d<\/p>\n\n\n\n

The reality is that you\u2019re not going to do that. Just like you wouldn\u2019t finish a marathon in under 3 hours without any training. You won\u2019t hit a home run at Wrigley Field (spring training starts this week) without years of practice. You won\u2019t lose 15 pounds without first losing \u00bd a pound.<\/p>\n\n\n\n

Improving requires small steps, and you cannot fast forward to the good parts.<\/p>\n\n\n\n

Fail to Improve<\/strong><\/h2>\n\n\n\n

In my estimation, we improve by making mistakes and learning from them. When I speak to groups about my professional experience and the options business, I\u2019ll point out that \u201cwe are all clerks\u201d at some point.<\/p>\n\n\n\n

I started learning about options in late 1999. My first job after graduation was as a clerk for an independent market maker on a trading floor. In that role, I was able to learn the language of options. I was able to ask questions and learn a little bit more every day. I was able to establish a foundation upon which to build. Eventually, I was entrusted with firm capital and given the opportunity to manage options risk on my own.<\/p>\n\n\n\n

In my opinion, we are all \u201cclerks\u201d in one way or another. Apprentice may be a more appropriate term. Here is the part where I believe social media can be helpful. Today you\u2019re able to tap into a global community of practitioners. Individuals that are willing to share their learnings can accelerate your own education. Curating a thoughtful group of social media accounts with an options focus can be very helpful.<\/p>\n\n\n\n

There is No Substitute<\/strong><\/h2>\n\n\n\n

In order to get started trading options, you have to trade an option. Period.<\/p>\n\n\n\n

If you have investable capital, you need to make sure you have options approval from your brokerage firm. There are usually levels that distinguish the strategies you\u2019re able to employ. The lowest level will allow the account holder to buy options.<\/p>\n\n\n\n

Try it. Buy a call. Buy a put.<\/p>\n\n\n\n

Establish a plan for how you will manage your exposure and stick to it.<\/p>\n\n\n\n

If you buy a call option for $1.00, are you comfortable losing $100? Will you allow that call to expire worthless if the reference asset (stock, ETF or index) doesn\u2019t move beyond your strike price at expiration?<\/p>\n\n\n\n

If two weeks pass and the options decay to $0.50, will you plan on selling the call to close?<\/p>\n\n\n\n

What about if things go well?<\/p>\n\n\n\n

Entering a trade is relatively easy. The exit can be more difficult. This goes back to the planning element. If you paid $100 for an option and plan to sell it if it\u2019s worth $250 \u2013 follow your plan.<\/p>\n\n\n\n

Without a plan, we tend to bargain with ourselves when things go well. You might think, \u201cwow, I\u2019m so smart. This option is up 150%. What if it\u2019s worth $500 next week?\u201d<\/p>\n\n\n\n

I can tell you from experience that turning a winner into a loser STINKS!<\/p>\n\n\n\n

Using options requires discipline. That\u2019s why this article starts with a hard truth: starting anything new is difficult. Going back to my floor experience, I remember so many people saying, \u201cnobody goes broke taking profits.\u201d While it\u2019s not quite that simple, it\u2019s close to the truth.<\/p>\n\n\n\n

There will be positions that work well. There will be others that don\u2019t. You must be able to manage both emotionally.<\/p>\n\n\n\n

Markets are volatile. Whether you realize it or not, volatility is why we invest. Changes drive value whether you\u2019re talking about an index, a specific company (earnings, etc.) or options (time value). Absent change, there is no incentive to invest.<\/p>\n\n\n\n

Understand that you will lose money at some point<\/strong>.<\/p>\n\n\n\n

It\u2019s about learning from every trade. I believe you learn more from losing positions than winners.<\/p>\n\n\n\n

Risk First, Not Reward<\/strong><\/h2>\n\n\n\n

There\u2019s a reason that financial marketing and presentations include disclaimers. Humans tend to be forward-looking and often optimistic. It\u2019s part of what moved us to the top of the food chain. However, that tendency can be problematic.<\/p>\n\n\n\n

There\u2019s a cost associated with everything<\/strong>: monetary costs, opportunity costs, emotional costs.<\/p>\n\n\n\n

Thinking about the risk inherent in any given options position as opposed to the potential reward is recommended.<\/p>\n\n\n\n

Ask yourself:<\/p>\n\n\n\n