When teaching others to use options, I ask students to possibly start with writing covered calls. Many other writers/teachers suggest that the newbie begin by buying options.
The idea behind either choice is to give the newcomer an opportunity to learn how options work by watching a live position. Observing how the price of an option changes on a daily basis makes it easier to understand delta and theta. In other words, the sometimes frightening topic of ‘the Greeks’ can be introduced early in the education process.
However, the major difference in approach is significant and represents my philosophy of option trading.
- Owing stock and writing an in-the-money call option fits that bill
- Buying an option with no idea of how that option is priced is not smart
- Covered call writing is a natural extension. Buy stock and then collect a premium for giving another trader the right to buy your stock
What about Iron Condors?
A topic that gets a great deal of attention for experienced traders at Options for Rookies is the Iron Condor.
When someone who is new to options begins trading by adopting the iron condor, I find it disturbing. Some new traders are ready for this strategy because they have done their reading, practice trading and believe they really do understand how to manage these trades. Make no mistake about it – managing risk and protecting your assets is the key to long-term survival for any trader.
The problem occurs when a new trader is not truly prepared for this more-advanced strategy. Not prepared? How is that possible? I’m a strong believer in reading and studying. However, the trader who lacks experience is going to find it difficult to function efficiently when faced with a trade that is losing money – and possibly losing quickly because of a volatile market. This is where the experienced trader has a big advantage. That experienced person knows whether to exit quickly and take the loss, or which of several risk-reducing strategies has worked best in the past, etc. The new trader is often undecided. If that trader has good instincts, then he will neither panic nor freeze. However, I believe that most new traders should only trade (with real money) strategies that are well within their comfort zones. And that’s the problem.
I encourage each of you to trade as you believe is best. However, the new trader may not be aware of how well-trained she is. The bottom line is this: DO NOT trade the iron condor if you don’t feel ready to do so. The covered call is much easier to understand, but it is also a strategy with greater potential loss.
The bottom line is measuring and managing risk. So please, trade appropriate size. Do not place money at risk when you cannot afford to lose. Trading small position size can give you all the training needed for future success. If you have the patience to learn, gain experience, grow as a trader and increase position size gradually, your chances of doing well could be greatly enhanced.
Mark D Wolfinger
Options for Rookies
Options involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options, sent to you in previous communication. Additional copies may be obtained by calling TRADEKING at 877-495-KING or by visiting www.TradeKing.com/ODD.
System response and access times may vary due to market conditions, system performance, and other factors.
Market timing is a complex investment strategy which involves risk and may incur additional commission costs.
The Greeks represent the consensus of the marketplace as to how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that these forecasts will be correct.
Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax advisor.
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All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. You alone are responsible for evaluating the merits and risks associated with the use of TradeKing's systems, services or products.