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The complete 2020 Guide for Beginners to options trading
The basis for many profitable trading approaches is the diversification of the investment portfolio and options serves this purpose perfectly. This is not surprising, since options trading gives the opportunity to use high trading leverage, hedge the risks of their other trades and the risk strategies.
Today some traders show interest in that but have no idea where to start. The others believe that it is risky for beginners as well as for trading veterans. The risk is posed by particular trading approaches, which are employed by the ones who either do not understand the risks involved or increase the risk level on purpose, aiming to get bigger returns. So in order to protect oneself against destructive losses one must obtain necessary proficiency in terms of options trading, its main aspects along with basics.
First of all, let`s see what an option is. An option is a derivative financial instrument that gives the right (but does not oblige) to buy or sell a particular asset within a specified period of time and at a price that is set in advance. It is a bilateral contract, so for the writer who grants it, it means an obligation to perform the prescribed action at the time of expiry. It is not even the derivatives themselves that are of great interest to execute but to trade options to profit from speculation.
There are two types of options – CALL, with this one, you can buy shares later: PUT option – is the one that gives you an opportunity to sell.
Options trading. Main advantages.
We can outline three main advantages of options trading:
- Options trading is a perfect tool to get a solid income because once we sell options, we receive a reward.
- It can be applied to ensure your investment portfolio. This is the causative purpose of organizing this kind of contract.
- Options refer to the group of derivatives, that creates an opportunity to analyze the values not only of the underlying asset but plus the fluctuations in the derivatives from these assets. Here the initial derivative is volatility, which is much easier to forecast moves in the prices of substantive assets. Otherwise speaking, one does not have to surmise where precisely and when the value of the selected asset will be. It will be possible to get a profit if the market rises, falls or even stands still.
An essential consequence of the aforementioned characteristics of options trading is that it remarkably – a) increases the potential reward/risk proportion; b) degrades the demands for the quality of predictions – in case of trading not with “bare options”, but with different mixed approaches being used.
What moves the prices?
Needless to say, that when you make your mind to dive into the options trading, you should check and learn what aspects define the value of an option. They are stock price, the strike price ( set price at which a derivative contract can be bought or sold when it is exercised), type of option (CALL/PUT), interest rates, dividends, time to expiration, and future volatility. Even with so many aspects of the equation, the Black-Scholes Model is still the most popularly applied. Its ease of calculation and valuable approach form a solid footing to build more complicated models. Out of the named factors, volatility is the only one that is calculated. And the most significant ones are stock price, strike price, type of option, time to expiration and volatility. Interest rates and dividends have very little impact on an option’s value.
Speaking about the risks of working with options, it is worth going back to the essence of these contracts once again: options are primarily effective as a tool to control (reduce) risks in exchange trading. But the combination of different assets of a fixed-time market is a nontrivial task. To understand the principles of working with options contracts, let us describe the main strategies.
1. Selling Covered Calls
In this case, we sell the rights to the underlying asset that we own. Selling Covered Calls can be considered an ideal strategy for those who want to create additional returns on shares that are already in their portfolio. If you are just beginning to study option trading, this strategy will be a good and, most importantly, a fairly safe option. It is also used to sell shares that we no longer need, despite a certain upside potential shortly. You are selling shares at the current price, but with a short grace period and additional commission for you.
Risks: The price of the shares you own may fall notably. In this case, the buyer has the right to withdraw from the deal, and you remain the owners of the cheaper shares, which you expected to sell at a higher price.
2. Buying Call or Put
Another variant is to buy options. In this case, you acquire the right, and you may withdraw from the deal.
This is a popular strategy among speculators, who are good at predicting medium-term movements on the market of the selected asset. The advantage of the strategy is the fact that you do not have to guess the price at the time of the expiration of the option. Even with a slight movement in the right direction, the reward from your options increases and you can safely sell it in the market with profit.
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Your risk here is to lose the reward paid if our analysis of the price movement of the selected asset is wrong.
3. Protective Put
Besides speculative purposes, you can buy Put options to protect existing open long positions in the stock market. For example, if you predict that stocks in your portfolio may become cheaper in the next two or three months, you can buy Put options as fall insurance.
If the price of your shares does indeed fall, the value of your option will increase, partially compensating for the losses. If the price of the shares does rise, you will simply reject the right to sell your shares at the agreed price on the expiration date. In doing so, you will only lose the reward, which in this case should be regarded as standard insurance.
Now let`s have a look at the risks associated with options trading.
Anyone who buys an option, even if he is a dummy, i.e. the right to sell or buy the underlying asset, to play on the difference in prices or values, risks are essentially limited only by the size of the reward. In case of an unfavorable combination of circumstances, the right is simply not exercised; it is closed either after the expiry of the term or by entering into an offset deal. So, it turns out that the profit is not limited by anything and losses are of a fixed size.
Everything is quite different for the writer (seller), that is, the second party. The profit is limited by the size of the reward and possibly by some additional value, in case the contract was covered and the assets were acquired at more favorable prices. Losses are not limited by anything. At a minimum, there will be a loss of margin in the exercise of an option exercised as a guarantee. At the maximum, this is the loss of all funds in the client’s account.
Such imbalance, asymmetry in risks can seriously shake the confidence in this financial instrument for beginners, but it all depends on the strategy and experience of the investor. Weighted thought-out options trading can be an excellent factor for diversifying your investment portfolio, a way to gain additional profit, given the high liquidity of the instrument.
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4 Effective Trading Indicators Every Trader Should Know
When your forex trading adventure begins, you’ll likely be met with a swarm of different methods for trading. However, most trading opportunities can be easily identified with just one of four chart indicators. Once you know how to use the Moving Average, RSI, Stochastic, & MACD indicator, you’ll be well on your way to executing your trading plan like a pro. You’ll also be provided with a free reinforcement tool so that you’ll know how to identify trades using these forex indicators every day.
The Benefits of a Simple Strategy
Traders tend to overcomplicate things when they’re starting out in the forex market. This fact is unfortunate but undeniably true. Traders often feel that a complex trading strategy with many moving parts must be better when they should focus on keeping things as simple as possible. This is because a simple strategy allows for quick reactions and less stress.
If you’re just getting started, you should seek the most effective and simple strategies for identifying trades and stick with that approach.
Discover the Best Forex Indicators for a Simple Strategy
One way to simplify your trading is through a trading plan that includes chart indicators and a few rules as to how you should use those indicators. In keeping with the idea that simple is best, there are four easy indicators you should become familiar with using one or two at a time to identify trading entry and exit points:
- Moving Average
- RSI (Relative Strength Index)
- Slow Stochastic
Once you are trading a live account a simple plan with simple rules will be your best ally.
Using Forex Indicators to Read Charts for Different Market Environments
There are many fundamental factors when determining the value of a currency relative to another currency. Many traders opt to look at the charts as a simplified way to identify trading opportunities – using forex indicators to do so.
When looking at the charts, you’ll notice two common market environments. The two environments are either ranging markets with a strong level of support and resistance , or floor and ceiling that price isn’t breaking through or a trending market where price is steadily moving higher or lower.
Using technical analysis allows you as a trader to identify range bound or trending environments and then find higher probability entries or exits based on their readings. Reading the indicators is as simple as putting them on the chart.
Trading with Moving Averages
One of the best forex indicators for any strategy is moving average. Moving averages make it easier for traders to locate trading opportunities in the direction of the overall trend. When the market is trending up, you can use the moving average or multiple moving averages to identify the trend and the right time to buy or sell.
The moving average is a plotted line that simply measures the average price of a currency pair over a specific period of time, like the last 200 days or year of price action to understand the overall direction.
Learn Forex: GBPUSD Daily Chart – Moving Average
You’ll notice a trade idea was generated above only with adding a few moving averages to the chart. Identifying trade opportunities with moving averages allows you see and trade off of momentum by entering when the currency pair moves in the direction of the moving average, and exiting when it begins to move opposite.
Trading with RSI
The Relative Strength Index or RSI is an oscillator that is simple and helpful in its application. Oscillators like the RSI help you determine when a currency is overbought or oversold, so a reversal is likely. For those who like to ‘buy low and sell high’, the RSI may be the right indicator for you.
The RSI can be used equally well in trending or ranging markets to locate better entry and exit prices. When markets have no clear direction and are ranging, you can take either buy or sell signals like you see above. When markets are trending, it becomes more obvious which direction to trade (one benefit of trend trading ) and you only want to enter in the direction of the trend when the indicator is recovering from extremes.
Because the RSI is an oscillator, it is plotted with values between 0 and 100. The value of 100 is considered overbought and a reversal to the downside is likely whereas the value of 0 is considered oversold and a reversal to the upside is commonplace. If an uptrend has been discovered, you would want to identify the RSI reversing from readings below 30 or oversold before entering back in the direction of the trend.
Trading with Stochastics
Slow stochastics are an oscillator like the RSI that can help you locate overbought or oversold environments, likely making a reversal in price. The unique aspect of trading with the stochastic indicator is the two lines, %K and %D line to signal our entry.
Because the oscillator has the same overbought or oversold readings, you simply look for the %K line to cross above the %D line through the 20 level to identify a solid buy signal in the direction of the trend.
Trading with the Moving Average Convergence & Divergence (MACD)
Sometimes known as the king of oscillators, the MACD can be used well in trending or ranging markets due to its use of moving averages provide a visual display of changes in momentum.
After you’ve identified the market environment as either ranging or trading, there are two things you want to look for to derive signals from this indictor. First, you want to recognize the lines in relation to the zero line which identify an upward or downward bias of the currency pair. Second, you want to identify a crossover or cross under of the MACD line (Red) to the Signal line (Blue) for a buy or sell trade, respectively.
Like all indicators, the MACD is best coupled with an identified trend or range-bound market. Once you’ve identified the trend, it is best to take crossovers of the MACD line in the direction of the trend. When you’ve entered the trade, you can set stops below the recent price extreme before the crossover, and set a trade limit at twice the amount you’re risking.
Learn More about Forex Trading with our Free Guides
If you’re looking to boost your forex trading knowledge even further, you might want to read one of our free trading guides . These in-depth resources cover everything you need to know about learning to trade forex such as how to read a forex quote, planning your forex trading strategy and becoming a successful trader .
You can also sign up to our free webinars to get daily news updates and trading tips from the experts.
How to Trade Stock Options for Beginners – Best Options Trading Strategy
This simple, profitable trading guide teaches stock options trading for beginners. The strategy applies to the stock market, Forex currencies, and commodities. In this article, you will learn about what options are, how to buy Put and Call options, how to trade options and much more. If options trading isn’t for you, try our Harmonic Pattern Trading Strategy. It’s an easy step by step guide that has drawn a lot of interest from readers.
The Trading Strategy Guides team believes this is the most successful options strategy. When trading, we adhere to the principle of KISS: “Keep it simple, Stupid!”
With simplicity, our advantage is having enormous clarity over price action.
We’ll be focusing on BUYING Put and Call options through this options trading tutorial. Selling options is a different animal. It requires more experience to fully understand the inherited risks. Why? Because you can’t control the downside, the same way you do when you buy Put and Call options.
This is the most successful options strategy because it consistently provides profitable trade signals. Not because it doesn’t have losses. The preferred time frame best options trading strategy is the 15 minute time frame.
We will first define what buying a Put and Call options is. After that, we will give out the rules for the best options trading strategy. Here is another strategy called The PPG Forex Trading Strategy.
What are Options?
Options are a specific type of derivatives contracts . The underlying securities can be stocks, indexes, ETFs or commodities . With a derivatives contract, you do not directly own the underlying asset. Instead, you own a related asset whose value is affected by changes in price.
With an options contract, you have the right to buy or sell an asset at a predetermined price in the future. When that future point arrives, you will have the choice to exercise the option or let it expire.
Here’s an example. Let’s say the asset is selling for $110, a contract giving you the right to buy at $100 will have an intrinsic value. As the expiration date approaches, the value of the options contract will adjust.
There are two different types of options, call options and put options. When used correctly, options trading will make your strategy much more dynamic. Let’s dive into the next section.
What is a Call Option?
A Call Option gives you the right to purchase an asset in the future. If exercised, this purchase will occur on a predetermined date. It will also occur at a predetermined value. If you are unsure about the future value of an asset, a call option can offer some protection. Call options are commonly purchased by stock traders. However, they can also be found in many other markets. In fact, call options are the most commonly traded options contracts.
What is a Put Option?
A Put Option gives you the right to sell an asset in the future. Like call options, these contracts have predetermined prices and sell dates. Put options and call options are often purchased together in order to make a “hedged” position. Below, we will discuss the different types of options sales. We will then discuss how these sales can be introduced into your trading strategy. You may also enjoy this article about options vs futures.
Different Types of Option Sales
It is necessary to remember that an option is a contract that allows you to purchase an asset at a specific price in the future. There are four different types of options sales that can possibly occur. The differences between short and long sales, and puts and calls will be very important.
- A long call option will give you the right to buy an asset at a specific price in the future. Long call option holders will benefit from price increases over time.
- A long put option will give you the right to sell at a specific price in the future. Contrary to call options, long put option holders are hoping that market prices will decrease.
- A short call option gives you the right to sell not the underlying asset, but the option itself in the future. Because the “logic” of short positions is reversed, short call option holders are in similar positions to long put option holders.
- A short put option will hope that long put options become less valuable over time—consequently, holders will be rooting for prices to go up.
Once you can understand the different varieties of options sales, you will be able to engage in more complex trading strategies. These strategies will usually involve purchasing multiple different options in order to manage risk and increase the possibility of earning high returns.
Why Use Options?
Options are used for speculation or hedging. Hedge fund managers are notorious for using advanced risk management strategies to hedge their market exposure.
Options offer high leverage, giving you the chance to trade big contracts and potentially make more money. This is the same for Forex. You need a smaller initial investment than buying stocks outright. When buying options, the risk is limited to the initial premium price paid.
When using options, the risk is limited, but the potential profit is theoretically unlimited. Obviously, we say theoretically unlimited profits. But options prices are going to be range-bound within certain parameters. There’s no stock price to rise to infinity. Also, read this article on Paper Trading Options – The Secret to Riches.
Types of Options Strategies
You can take your trading beyond basic call and put options. That is the beauty of options trading. Other trading strategies include covered call, married put, bull call spread, bear put spread, and more. They can help you better manage your risk and seek new trading opportunities.
If you’re a versatile trader, take advantage of the flexibility that options trading can give you. Study the top 10 stock options trading strategies below:
- Covered Call Strategy or buy-write Strategy – implies buying stocks outright. At the same time, you want to sell call options on the same stock. The number of shares you bought should be identical to the number of call options contracts you sold.
- Married Put Strategy – implies buying stocks outright. At the same time, you will buy put options for an equivalent number of shares. The married put works like an insurance policy against short-term losses.
- Bull Call Spread Strategy – implies buying call options with a specific strike price. At the same time, you’ll sell the same number of call options at a higher strike price.
- Bear Put Spread Strategy – it’s similar to the bull call spread but involves buying and selling put options. In this options strategy, you buy put options with a specific strike price. At the same time, sell the same number of put options at a lower strike price.
- Protective Collar Strategy – implies buying an out-of-the-money put option. At the same time sell or write an out-of-the-money call option for the same stock.
- Long Straddle Strategy – implies buying both a call option and a put option at the same time. Both options should have the same strike price and expiration date.
- Long Strangle Strategy – implies buying both an out-of-the-money call option and a put option at the same time. They have the same expiration date but they have different strike prices. The put strike price will typically be below the call strike price.
- Butterfly Spread Strategy – implies using a combination of the bull spread strategy and bear spread strategy. The classical butterfly spread involves buying one call option at the lowest strike price. At the same time, sell two call options at a higher strike price. And then sell one last call option at an even higher strike price.
- Iron Condor Strategy – involves holding a long and a short position in two different strangle strategies.
- Iron Butterfly Strategy – involves using a combination between either a long or short straddle strategy. At the same time, buy or sell a strangle strategy.
Now let’s turn our focus back to the most successful options strategy.
Let’s define the indicators you need for the best options trading strategy. And how to use stochastic indicator.
The only indicator needed is RSI or Relative Strength Index.
Options trading is constrained by the expiration date factor. So it’s important to select a technical indicator that is suitable for options trading. The RSI indicator is a momentum indicator which makes it the perfect candidate for options trading. This is because of its ability to detect overbought and oversold conditions in the market.
The RSI indicator’s location is on most FX trading platforms (MT4, TradingView). You will find it under the indicators library.
So, how does the RSI indicator really work?
The RSI uses a simple math formula to calculate the oscillator:
There is no need to go further into the math behind the RSI indicator. All we need to know is how to interpret the RSI oscillation. Basically, an RSI reading equal to or below 30 shows that the market is in oversold conditions. An RSI reading equal or above 70 shows the market is in overbought conditions. At the same time, a reading above 50 is considered bullish. On the other hand, a reading below 50 marks is considered bearish.
The preferred RSI indicator settings are the default settings with a 14 period.
Before we go any further, we always recommend taking a piece of paper and a pen and note the rules.
Let’s dive into the options trading tutorial….
Most Successful Options Strategy
(Rules for Buy Call Options)
Options Trading Tutorial Step #1: Wait 15-minutes after the stock market opens to establish your market bias.
The most successful options strategy isn’t focusing only on the price. But they also make use of the time element the same as we’re doing here.
The stock market opening price is usually the most important price. During the first minutes after the stock opening bell, we can note a lot of trading activity. This is because that’s the time when major investors are establishing their positions in the stock market.
Read Day Trading Price Action- Simple Price Action Strategy. You’ll learn about a strategy that isn’t restricted to the time element and focuses on price action. It’s one of the most comprehensive guides to successfully trade stocks or other assets by simply using price action.
Our team at Trading Strategy Guides wants to develop the best options trading strategy. In order to do that, we have to think smarter. We have to track how the smart money operates in the market.
The best options trading strategy will not keep you glued to the screen all day. You only have to know when the stock markets open.
The NYSE opens at 9:30 EST or 1:30 PM GMT time for those trading from Europe.
This brings us to the next step in our options trading tutorial…
Options Trading Tutorial Step #2: Make sure the 15-Minute candle after the opening bell (9:30 EST) is bullish.
As we have established earlier, we only want to trade in the direction where the smart money is. If we’re looking for buying Call Options opportunity we want to make sure smart money is buying after the open. Conversely, if we’re looking to buy Put Options we want to see sellers appear right after the opening bell.
Important Note*: If we have an opening gap up it means the buying power is even stronger and we should put more weight on this trade setup.
Options Trading Tutorial Step #3: Check if the RSI is above 50 level – This is a bullish momentum signal.
We use the RSI indicator for confirmation purpose only. We want to make sure that once we have identified the bullish price action the momentum behind the move is confirmed by the RSI indicator. We’re not concerned with overbought and oversold conditions because the market can stay in these conditions longer than you can stay solvent.
In the chart above, we can note the RSI is well above 50 during the first 15-minutes of trading. The price action is confirmed by the RSI momentum reading.
Now, let’s jump and define where exactly we want to enter our buy a Call option.
Options Trading Tutorial Step #4: Buy a Call option right at the opening of the second 15-minute candle after the opening bell.
Now, that we have confirmation that smart money is buying we don’t want to lose any more time and we want to buy a Call option right at the opening of the next 15-minute candle after the opening bell.
As easy as it sounds this strategy only requires you to put 15-minutes of your time each day. You’ll either get a signal or not, but in order to take advantage of the best options trading strategy, you need to exercise discipline and don’t take any trades if you don’t have any signal.
So at this point, our trade is running and in profit, but we still need to define when to exercise our call option and take profit.
Options Trading Tutorial Step #5: Choose the nearest expiration cycle. For day trading choose the weekly cycle.
When you buy a Call option you also have to settle an expiration date, as part of that contract.
You might be asking yourself how to choose the right expiration cycle?
Well, because we’re most likely going to sell our Call option the same day as we have purchased it, it’s more appropriate to choose the weekly cycle.
Time to switch our focus to the most important part: Where to take PROFITS and sell your Call Options?
Options Trading Tutorial Step #6: Take Profit and sell the Call Option as soon as you have two consecutive 15-minute bearish candles.
Knowing when to take profit is as important as knowing when to enter a trade. We want to get out of our position as soon as we see the sellers stepping in. We measure this by counting two consecutive bearish candles as a sign of bearish sentiment presence in the market.
You don’t want to exercise your long Call option because you don’t want to own those share stocks, you just want to make a quick profit.
Note** The above was an example of a buying Call option using the options trading tutorial. Use the exact same rules – but in reverse – for buying a Put option trade. In the figure below you can see an actual Buy Put Options example using the options trading tutorial.
We’ve applied the same Step #1 through Step#4 to help us establish our trading bias and identify the Buy Put Option trade and followed Step #5 through Step#6 to identify when to sell your Call option.
Selecting the Options Contract that’s Right for You
Now that you understand how to successfully trade options, you will want to know how to choose the contracts that are right for you. All options contracts will have some degree of risk. This is especially true when trading binary options. This is due to the fact that options can potentially be worthless on their expiration date. The risk of trading options can be managed.
When selecting options, keep the following things in mind:
- Your personal level of risk tolerance
- Your desired trading timeframe (day trading, long-term trading)
- The volatility of each prospective asset
- Past returns on options contracts
Options contracts also have high levels of implied volatility . During the first 30 minutes of trading, options contracts experience large changes in value. When volatility is high, both the level of risk and potential reward will be higher. During this time, your trading strategy will need to be much more active. Risk can be managed by issuing stop orders. It can also be managed by hedging your position and diversifying your positions.
Both call and put options can be very rewarding. In order to prepare yourself as an options trader, it will be a good idea to practice. Fortunately, Trading Strategy Guides makes it easy to hone your skills and enter new markets. Carefully combining the steps mentioned above can help you unlock the best options trading strategy.
Conclusion – Options Trading Tutorial
This is one of the most successful options strategies because when trading stocks, it’s important to have a good understanding of the market sentiment and how the big players are positioned in the market. Another important reason why this is the best options trading strategy is that you’re not required to be glued to the screen all day long.
Don’t forget also to read our Support and Resistance Zones – Road to Successful Trading one of the most comprehensive guides to successfully trade stocks or other assets by simply using support and resistance levels.
Thank you for reading!
Please leave a comment below if you have any questions on How to Trade Stock Options!
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