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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.
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.
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.