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Beginner's questions on options trading

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  #1 (permalink)
 Yuri57 
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Hi! I have never traded options but familiar with the basic principles (expiration, strike price, selling or buying etc).

I would like to dedicate this thread to asking beginner's questions if you decide you want to learn how to trade options.

Let me start with my list:

What time-frame are options suitable for trading? (Is it possible to daytrade; is it possible to have them for months?)

What is the typical value of an option of futures contracts? (NQ, GC, CL, 6E, etc).

What accout size would you recommend just to get started? (Also which broker and what do you consider a good comission price for trading options?)

Why do you think people trade futures instead of options?

Isn't selling options have unlimited downside? Why is it so popular?

Finally can you recommend any really good books on trading options?

Thanks,

Yuri57

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 rleplae 
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there are also options on futures ;-)

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 xplorer 
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rleplae View Post
there are also options on futures ;-)

So my first question, is there any difference between Options of Futures and Options on Stocks? Or is it the same difference between, say, Stock Indexes and Index Futures?

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 Yuri57 
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rleplae View Post
there are also options on futures ;-)

That's exactly what we are talking about.

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 tradergino 
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Юра,

There is an educational site called Tastytrade ( https://www.tastytrade.com/). It's a daily live show with segments that are recorded so you can watch them anytime. Tons of stuff on options along with a program called Dough that allows for probabilities in a variety of option trades. Best thing it's FREE.

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 suko 
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Yuri57 View Post

Hi! I have never traded options but familiar with the basic principles (expiration, strike price, selling or buying etc).

What time-frame are options suitable for trading? (Is it possible to daytrade; is it possible to have them for months?)

What is the typical value of an option of futures contracts? (NQ, GC, CL, 6E, etc).

What accout size would you recommend just to get started? (Also which broker and what do you consider a good comission price for trading options?)

Why do you think people trade futures instead of options?

Yuri57

I've been trading options for about a year, strategic style. Mostly spreads. So, from my limited experience:

I don't trade options on futures, but from what I hear they are not as liquid yet as options on equities. Since liquidity is important in trading options, this is a key fact. You want underlyings with large volume and a very narrow bid/ask spread. SPY, QQQ, TLT, AAPL, FB, NFLX, SBUX, GLD, VXX, IWM.

Some people daytrade single options just like stocks, trading the tape. They claim you can make more money doing this than trading the underlying cash product.

People trading spreads like me will trade longer duration to get the time value premium, for example opening positions in the range of between 20 to 60 days.

As for account size, to get good at options you need a lot of practice, and that means having a number of positions on, for example 10 or 20 or more. With a $10K account, for instance, you can have ten 1-lot positions on in lower-priced underlyings without exceeding about 50% of your buying power, which is a reasonable limit on portfolio size. With a $5K account you can have fewer positions and more risk relative to account size.

So, I would say at least a $10K account for a beginner. Bear in mind the fact that to really be profitable you need to be trading higher profit strategies like strangles and straddles and naked options that require more capital and higher permissions. $30K account allows you to do more of that stuff.

In other words, it's very tough to get profitable on a $10K account in options because you are restricted to doing the safer strategies that have lower probability of profit. So, it's best to look at a smaller account as good for learning the concepts -- but manage your expectations.

As for brokers, I hear a lot of people prefer the fee structure at IB or Optionshouse. I am using TOS with a discount via dough at $1.50 per contract. This is half the normal TOS price of $3, which is considered expensive. But even at $1.50 the commissions really, really rack up fast. Anyway, I think for a beginner maybe it is more important to be with a broker that has a good platform and worry about the commissions later, when you get to a higher level. TOS and dough are obviously good for beginnners, but you may not be able to get them where you are. Look into IB (although I think they require a bigger account to get permissioned for options).

As for why people trade futures rather than options. For one thing, you there's more leverage. For another thing, it's less complicated at the strategy level. Markets are open longer so you can trade more. I think it's best to be good at trading both options and futures, and use them as appropriate. For a directional play on bonds, for instance, /ZB may be more efficient than options on TLT.

As for unlimited downside with selling options. If you stick to trading SPY, QQQ, TLT, AAPL, FB, NFLX, SBUX, GLD, VXX and IWM, none of these things are going to go to zero today. And conversely, they are not going to go to the moon, today, with the exception of VXX.

In the case of VXX (and UVXY) the rule is never sell naked options, only sell defined risk spreads. In general tread lightly in dealing with volatility products because they cause the worst account blowups. VIX calendar spreads being the worst.

Anyway, as a beginner, you will only be permissioned to trade defined risk spreads: credit and debit spreads, iron condors, and covered calls and so forth. So you don't have to worry about unlimited downside as a beginner.

So, a basic formula is trade those ten products and restrict yourself to one lot spreads and covered calls, collect 1/3 of the width of the strikes on the spread in the front month or back month duration. Take the position off at 50% of max profit and reload at a later expiration. Learn to manage your portfolio of these underlyings to within +/- 100 deltas on your $10K account.

As for books, Michael Sincere has a couple of books that are very well written and easy to understand, such as "Understanding Options 2E".

But as another poster mentioned above, there is about 5000 hours of video content on tastytrade.com and if you watch much of this you may not need or want a lot of books to get started. Their "doughjo" interactive e-learning course is very good. Watch the beginner oriented episodes of "Ryan and Beef" and "Mike and his Whiteboard" (watch this one from the beginning).

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 Yuri57 
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@Suko, thanks for the long reply.

I don't intend trading frequently, nor having 10 positions all the time or sell premium for that matter.

I want to make directional bets on commodities, interest rates, FX rates and volatility. Speaking of which, when I buy volatility who is on the other side of the trade? Seems like a no-brainer to buy volatility when it's low.

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 suko 
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Yuri57 View Post
@Suko, thanks for the long reply.

I don't intend trading frequently, nor having 10 positions all the time or sell premium for that matter.

I want to make directional bets on commodities, interest rates, FX rates and volatility. Speaking of which, when I buy volatility who is on the other side of the trade? Seems like a no-brainer to buy volatility when it's low.

You're welcome. Take what you like and leave the rest.

I am specializing in volatility trading, please take a look at my journal in the Elite section. I find I cannot manage 10 directional positions at my level of skill and knowledge. If I focus on one thing, maybe.

It's very hard to make money long volatility, whether buying or selling. The counterparties, especially the VX traders, are known as rocket scientists for a reason.

Short Vol is where the money is made.

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 Yuri57 
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suko View Post
You're welcome. Take what you like and leave the rest.

I am specializing in volatility trading, please take a look at my journal in the Elite section. I find I cannot manage 10 directional positions at my level of skill and knowledge. If I focus on one thing, maybe.

It's very hard to make money long volatility, whether buying or selling. The counterparties, especially the VX traders, are known as rocket scientists for a reason.

Short Vol is where the money is made.

You just made me very interested in trading volatility. Hm. I will check your journal for sure! Thanks.

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 Bookworm 
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If you want to make directional trades intraday then either use futures or 50 Delta or higher calls or puts. If your time frame is longer then you can add more sophisticated option spreads but every time you stray from the underlying with options, you add to the slippage, bid/offer spread and commissions that take away from your bottom line. The big advantage to options is you can create strategies not only for direction but for sideways markets that don't offer opportunities in the underlying but you then need a thorough understanding of volatility and how it affects option pricing.

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 ron99 
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Yuri57 View Post
Isn't selling options have unlimited downside? Why is it so popular?

Finally can you recommend any really good books on trading options?

Thanks,

Yuri57

Futures also have unlimited downside.

Selling options is popular because you don't have to be correct directionally to make a profit. If you sell puts and futures go up you make a profit. If futures stay flat you make a profit. If futures drop some but not a lot you make a profit. If futures drop a lot, but you don't have to exit, and then futures go up you make a profit.

Carley Garner has several books on commodity options.

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 Yuri57 
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ron99 View Post
Futures also have unlimited downside.

Selling options is popular because you don't have to be correct directionally to make a profit. If you sell puts and futures go up you make a profit. If futures stay flat you make a profit. If futures drop some but not a lot you make a profit. If futures drop a lot, but you don't have to exit, and then futures go up you make a profit.

Carley Garner has several books on commodity options.

What if you futures drop a lot and than drop a bit more? How much do you lose?

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ron99 View Post
Futures also have unlimited downside.

Selling options is popular because you don't have to be correct directionally to make a profit. If you sell puts and futures go up you make a profit. If futures stay flat you make a profit. If futures drop some but not a lot you make a profit. If futures drop a lot, but you don't have to exit, and then futures go up you make a profit.

Carley Garner has several books on commodity options.

This is probably the most inaccurate statement about Options as far as Risk is concern. Your description sounds like "set it and forget it".
Option selling has its benefits, but sellers are short volatility, and whoever is short volatility finds out that the underlying instrument does not have to move much during certain periods in order for the Options to expand exponentially. Sellers can buy back at a loss not linear to their expectations.
No one can say conclusively that the use of futures is better than options or vice versa.
They both have different risk components that the player accepts and feel comfortable with.

Matt Z
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 ron99 
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mattz View Post
This is probably the most inaccurate statement about Options as far as Risk is concern. Your description sounds like "set it and forget it".
Option selling has its benefits, but sellers are short volatility, and whoever is short volatility finds out that the underlying instrument does not have to move much during certain periods in order for the Options to expand exponentially. Sellers can buy back at a loss not linear to their expectations.
No one can say conclusively that the use of futures is better than options or vice versa.
They both have different risk components that the player accepts and feel comfortable with.

Matt Z
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There is a risk of loss in futures trading. Past performance is not indicative of future results.

And it is inaccurate of you to assume how close to ITM the position is and how much of account is used to cover margin.

If you are far enough OTM and have enough cash excess then you can set it and forget it in most situations.

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 ron99 
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Yuri57 View Post
What if you futures drop a lot and than drop a bit more? How much do you lose?

You need to provide a lot more info for someone to answer that question. What commodity? What position? How much did futures move?

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 HoopyTrading 
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ron99 View Post
You need to provide a lot more info for someone to answer that question. What commodity? What position? How much did futures move?

Ron99, whoa. Quite a statement there, and above. Futures have unlimited downside....They also have unlimited upside. But their few limits are set by the exchange, including trading price limits and expiration dates. I dunno' what options entail with this sort of thing, but I think you might be askew here. We do NOT need unlimited up or downside. We need comfort zones, yes??

Options scare the heck out of me. Futures seem much more straight-forward.

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 suko 
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mattz View Post
Option selling has its benefits, but sellers are short volatility, and whoever is short volatility finds out that the underlying instrument does not have to move much during certain periods in order for the Options to expand exponentially.

A note for beginners, if it's not already obvious. There is a tribal language used in options that participants can often use in ways that are confusing.

For instance the "short volatility" above is slightly different from the "short Vol" I mention in my post above. mattz is referring to the general strategy of shorting options with elevated or higher implied volatility.

Where I wrote "short Vol" I was referring specifically to the volatility asset class alone, and pretty much VXX alone.
You can employ a short vol strategy with VXX regardless of whether IV is high, because you are hoping to harvest contango in addition to premium. Of course all the better if IV is high. I guess the result of shorting volatility is the same for all classes, but I think it's amplified with options on volatility products in particular.

When people refer to "short volatility" in most cases they are referring to what mattz is discussing, not volatility trading outright.

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ron99 View Post
And it is inaccurate of you to assume how close to ITM the position is and how much of account is used to cover margin.

If you are far enough OTM and have enough cash excess then you can set it and forget it in most situations.

I did not assume whether an option is ITM or OTM, neither did I talk about one's equity.
My discussion was a general comment as a response to your comment about Options.
The problem with your approach, in my opinion, exactly as you stated it "most situations"

Options selling is not about most situation, rather those one in a while event that spikes in volatility cause options premiums to explode. This is the debate that I have most option sellers, where their approach to options is that the further away from the money it is, the less risky. This is exactly the opposite, because the premium you collect is so small while the risk you assume is enormous. Look at situations like 2008, or Aug 2015, or look at physical commodities, where small limit move could integrate into the Options a move of 10-15 points. In the early 2000's (cant recall 2003-2004) a limit move of 1.5 points in cattle affected options that were 20 dollars out by X10 premium.

Nassim Taleb the author of Anti Fragile and Black Swan was an option traders. His entire theory about Black Swan events was the one overlooked variable of risk that gets most into trouble, therefore, again your "most situation" is misleading.

Ron, I hope you understand that my disagreement with you is professional and not personal. Many people read these posts who come from many levels. We should not set precedence that any strategy is easy.

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Trading futures and options involves substantial risk of loss and is not suitable for all investors. Past performance is not necessarily indicative of future results. You may lose more than your initial investment. All posts are opinions and do not claim to be facts. Please conduct your own due diligence. Use only Risk capital when trading Futures.
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 suko 
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HoopyTrading View Post
Options scare the heck out of me. Futures seem much more straight-forward.

We need to point out again that as a beginner option trader you will not be permissioned for "undefined risk" products, so this talk of unlimited downside is for more advanced traders, who have Tier 3 permission to sell naked options. As a beginner you will only get Tier 2.

So, there are "defined risk" and "undefinied risk" strategies.

One good example of "defined risk" that beginners usually trade is an iron condor. It's a combination of two directional defined risk spreads, long and short. Underlying goes up a certain amount or stays the same, you make money, if it goes down a certain amount or stays the same you make money. Beautiful.

The amount of risk is set when you open the trade. It's an absolute limit, (unlike a stop loss with other types of trading).

It's the epitome of the goodness of option trading. Nothing scary about it, except the name.


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 Big Mike 
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@suko what platform is that?

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 suko 
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@suko what platform is that?

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That's dough. Same dev team that did TOS. Next-gen TOS in a sense.

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Yuri57 View Post
@Suko, thanks for the long reply.

I don't intend trading frequently, nor having 10 positions all the time or sell premium for that matter.

I want to make directional bets on commodities, interest rates, FX rates and volatility. Speaking of which, when I buy volatility who is on the other side of the trade? Seems like a no-brainer to buy volatility when it's low.

Yuri,

I've managed a book of options risk here in London. Our clients were only institutional clients and everyone at the desk had at least a master in mathematics if not a PhD.

Buying volatility is the worst thing you can do. There is a huge asymmetry in the bid/offer spread of options, so that the buyer of the option is always screwed. In other words, buying volatility has a HUGE theta cost - every day you will pay a lot to hold that insurance and over 1 or 2 years you will lose 99.9999% of your deposit.

I would strongly advise you NOT to deal with options, unless you are willing to go through 700 pages of Hull's book on options and derivatives.

When I say options I mean vol > they're the same, even the VIX is essentially the price of the vol spread on options.

Regards

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Edit: the only guys I know who make money on options are actually selling volatility. in order to sell volatility without getting blown up (like 99% of the guys who thing trading vol is easy), you need to :
- have a clear understanding of greeks: gamma, theta, vega, delta, etc.
- have a clear gamma-hedging strategy that you can execute to reduce your gamma losses
- have models that will price the vol of instruments in a better way than Black & Scholes, in order for you to find "under-priced" or "over-priced" vol.

If you have an intellectual interest in this, read Hull's book, it's 150$ and will take you probably a good year before you finish it and understand it.

If you just want to make money..... stay away of all of this.

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