Option trading provides the advantage of flexibility that ordinary share trading does not. This is because options have so many more variables than just buying shares and selling for a profit. You can use these variables to your advantage.
2Be prepared to draw parallel lines. This way you can tell when a stock is "channeling." This means that the stock's daily highs and lows remain within a particular price distance of each other. These channels can either be ascending (rising over time), horizontal (neither rising nor falling over time) or descending (falling over time). Ascending and descending channels have opposite "slopes." Not all stocks channel, but many do. Look for these.
3Be able to draw horizontal lines that mark out "support" and "resistance" levels where a stock has broken through or settled upon a given price mark.
4Look for shares that have options on them. Not all shares do, so you need to know these. Your broker or stock exchange can provide you this information.
5You also need to be able to compare "daily" and "weekly" charts, to determine where a stock currently is in its longer-term direction. See if you can draw parallel lines (and thus detect channeling) over the weekly charts.
6Determine where a stock currently is within the channel. You may even have a "channel within a channel". First determine the strength (slope) of the larger channel. Then you can tell the reliability of the more immediate channel to "do its thing."
7If the channel is telling you the stock should rise, you want to buy call options with at least 45 days until expiry. If the signals are telling you the stock should fall, then you buy put options. The best places to buy are at the tops or bottoms of channels, but first wait for the "bounce" to validate your expectations. If the stock breaks through the channel, take an opposite position.
8Options provide you with far more leverage than shares and are far safer to trade than Contracts For Difference (CFDs). They give you the flexibility of holding an "each way" position if you like, because you can hold both call and put options at the same time for the same strike price and expiry date or any variation thereof.
9Understand that your profits will be far greater with much less capital risk by trading options than if you owned the actual stock.
- If the stock reaches the bottom of a channel, a good strategy is to buy an "out of the money" call option, because you're expecting it to bounce upward. If instead it continues to fall, then you buy an "out of the money" put option and make a profit from that. This will usually cover your loss on the failed call option. Quite often when the stock retraces or bounces back you'll make a profit on the call options. The reverse applies for the top of a channel.
- Understanding option volatility is important. You want to ensure that you're not paying too much for an option contract. Since the options market is based on another market but not rigidly linked to it in terms of price, you can find overpriced and underpriced options, especially when they're "out of the money". Beware of these.
Things You'll Need
- A good broker who allows you to trade options and gives you the chance to place your trades online.
- A charting package, whether you buy one or use one of the free, web-based versions.