Navigate Your Way to Successful Trading in 6 Key Steps: A Comprehensive Guide
Diving into the world of options trading, you'll find no end to the strategies you can implement! From a simple buy and sell to complex spreads like butterflies and condors, the choice is yours. Options are available on everything from stocks to currencies, commodities, exchange-traded funds (ETFs), and futures contracts.
With a myriad of strike prices and expiration dates for each asset, it can be overwhelming for the option beginner to find a suitable trade. But fear not! Following six simple steps, we'll guide you through the process of evaluating and identifying the right option to fit your trading strategy and maximize success in the market.
The Six Steps
1. Formulate your investment objective
Begin with your trading objective: Is it to speculate on a bullish or bearish view of an underlying asset, hedge potential downside risk, or generate income by selling option premiums? Crafting a clear trading objective is essential for the following steps.
2. Risk/reward ratio
Consider the risk you're willing to take against the potential reward. If you're a conservative investor, you might shy away from aggressive strategies, while an aggressive trader might go all-in on long shots.Make sure you understand and are comfortable with the risk and reward profile of each strategy.
3. Check the volatility
Implied volatility plays a significant role in determining an option's price. Get a good understanding of the level of implied volatility for the options you're looking at. Compare it with the stock's historical volatility and broader market volatility as this will impact your trading decisions.
4. Identify events
Events can have a significant impact on an underlying asset's price. Whether it's market-wide events like Federal Reserve announcements or economic data releases, or stock-specific events like earnings reports and product launches, these events can alter volatility levels and play a crucial role in your trading strategy.
5. Strategize
Based on the results from the previous steps, devise a strategy that meets your investment objectives. Do some research and find the strategies that best suit your risk tolerance, volatility expectations, and the events impacting your chosen underlying assets.
6. Set your options parameters
Now that you've identified the strategy you want to implement, choose the expiration dates, strike prices, and option deltas that best fit your strategy. Remember, an in-the-money (ITM) call has a strike price below the underlying asset's current price, while an out-of-the-money (OTM) call has a strike price above the current price.
With these six steps in mind, you're well on your way to finding the right option for your trading strategy and maximizing your success in the market.
Let's Put It Into Practice
Here are two examples using traders with different strategies and objectives:
Conservative Investor:
- Objective: Hedge position in 1,000 shares of McDonald's (MCD).
- Risk/Reward: Aims to limit risk while still maintaining a quantifiable gain.
- Volatility: Checks both implied and historical volatility for ITM put options with different expiration dates.
- Events: Focuses on events past the earnings report for MCD.
- Strategy: Purchase put options to hedge against potential downside risk.
- Parameters: Chooses expiration dates and strike prices based on research and the ideal expiration date past the earnings report.
Aggressive Trader:
- Objective: Become bullish on the prospects of Bank of America (BAC) and has $1,000 for trading.
- Risk/Reward: Thrives on high-risk, high-reward opportunities.
- Volatility: Examines implied and historical volatility for OTM call options with different expiration dates.
- Events: None, wants to focus on the long-term potential of BAC.
- Strategy: Purchase OTM calls to speculate on a surge in the stock price.
- Parameters: Chooses expiration dates and strike prices based on research, aiming for high potential reward.
- To maximize profits from a bullish view of Bank of America (BAC), the aggressive trader may decide to participate in decentralized finance (defi) trading by investing in an Initial Coin Offering (ICO) for a token related to the finance sector.
- In the process of evaluating suitable options for diversifying their portfolio, a conservative investor might turn to investing in Exchange-Traded Funds (ETFs) that cater to defi or blockchain projects, providing a low-risk avenue for exposure to this burgeoning sector.
- As part of their research for implementing an options trading strategy involving a defi token, both conservative and aggressive traders should consider factors such as the token's historical price movements and any upcoming project updates or partnerships that could potentially impact its value.
