Here are nine easy tips for new options traders to follow if they want to be successful.
Options are best used as risk-reducing investment tools, not instruments for gambling. (Read my article, why trade options?)
Use the options Greeks to measure risk.
Manage risk carefully. Do not hold any position than can – in the worst case scenario – cost more than you are willing to lose.
Be careful about the number of option contracts you trade. It’s easy to over-trade with inexpensive option contracts – especially when selling.
Don’t go broke. Never allow an unexpected event to wipe out your account.
Do not expect miracles. Do not buy options that are far out of the money just because they are ‘cheap.’ The chances of success are tiny. Not zero, just tiny.
Selling naked options is less risky than buying stock. But, like stock ownership, there is considerable downside risk. Exception: It’s reasonable to sell naked puts – but only if you want to buy the shares, if assigned an exercise notice.
Limit losses. The most effective way to accomplish that is to buy one option for every option you sell. That means selling spreads, rather than naked options.
Hope is not a strategy. When a position goes bad, consider reducing risk. Doing nothing and hoping for a good outcome is nothing more than gambling.