Those who buy and sell options do so in order to hedge their risk, lock in opportunities or both. In doing so, traders employ any and all option trading strategies. Your choice of one or all option trading strategies will depend on your purpose in trading, the market, and current market conditions. To help our readers sort out the reasons for using one approach versus another we offer a few useful suggestions.
What Is Difference between Options and Futures Trading?
Futures and options are similar as trading products in that they give investors the opportunity to hedge their investments and make money. But, they differ in terms of absolute risk. When you purchase an options contract you obtain the right to buy or sell shares on or before a specific date called the expiration date. However, you are under no obligation to do so. You are simply paying to have that option. The seller, on the other hand, is obligated to sell if the buyer executes the contract. Futures contracts confer the right to purchase on or before the expiration date and these contracts are not optional.
Dispersion Trading Using Options
Dispersion trading using options takes advantage of two facts. There is always a difference between implied and realized volatility when trading. And, this difference is always greater between index options as opposed to individual stocks. In this method of trading one will either buy individual stock options and sell options on an index or buy options on the index and sell individual stock options. Dispersion trading works the best, obviously, when there is low correlation between individual stocks and works poorly when correlation is high. A good example might be today’s stressed market in which the broader market rises and falls with good or bad news but individual stocks continue to perform based on their intrinsic stock value.
When Do Spy Options Stop Trading?
The SPY refers to the ETF or exchange traded fund that tracks performance of the S&P 500. You can trade options on this index during the day until 4:15 pm the settlements are based on the 4 pm market closure. Depending on the broker, you have until as late as 5 pm to get out of an option contract that has passed from being profitable to being a loser. You can trade SPY options after hours but the rules are different and liquidity goes way down. You cannot place market orders but need to place limit orders. This means you are not guaranteed an option contact. And, you had better pay close attention to your trades as positions can change more quickly and less fluidly that during the day!
Option Trading Buy Call
A call option is a good first step for new options traders. Sadly, many potential options traders are deterred by the common misconception about nine out of ten options expiring worthless. If this were true you would predictably lose money (your payment for the option on 90% of trades. However, the fact is that while three out of four options expire worthless, six out of ten are either closed by creating an offsetting position or traded out. In the end, one in ten call options is exercised. The reason for buying a call option without any other actions is that you believe the stock or other equity will go up in value between when you make your purchase and when you exercise the option. For this approach to be profitable over time you need to analyze your potential trades sufficiently well so that your total gains exceed the costs of all of the options contracts that you buy.
Trading Low Volume Options
One of the pitfalls in trading options is buying an option contract for an equity with low trading volume. If the stock trades at low volume, the price of the option contract may be irregular and hard to predict. And, if the options contracts trade at low volume you may find yourself trapped in a trade when you want to get out! Additionally, higher trading volume gives you a better sense of the movement of an equity. This is, of course, why options traders purchase options as they seek to profit from swings in price due to both fundamental and technical factors. Many traders rely on a big increase in trading volume as an indication that a large price move is in the offing while they look at a drop in volume as an indication that their trade will probably be a loser.
Trading Options on Ninjatrader
If you want to be active in trading options it is best to use a trading platform. The Ninja Trader platform has been available since 2003 offering both brokerage services and trading software. Many traders use its free market analysis, charting, and live trading functions as well as simulation trading functions. This is a very functional setup at the basic (and free) level but if you want special features like automated trading, back testing, and advanced order types you need to pay on one-time fee of about $1,000 or a monthly leasing fee of about $60. The point of using the advanced features is that these tools can make your trading more successful and profitable, but you need to learn them and use them regularly.
Best Books about Trading Options
Options trading can be quite profitable but you need to learn the necessary skills. There are three books that we recommend that will help demystify this pursuit.
Option Trading and Pricing by Sheldon Natenberg is at the top of almost everyone’s list of best books about trading options.
This book is great for beginners and pros as it outlines practical trading strategies that reduce risk as well as more advanced hedging techniques. It even tells you how tax laws affect your option trading profits!
Fundamentals of Futures and Options Markets by John Hull is our second choice.
This a good book for active option traders as it contains lots of actionable advice from an authority on risk management in trading derivatives.
Option as a Strategic Investment by Lawrence McMillan is ranked first by many experts, but we place it third.
This author provides a ton of useful information but our take is that it may be a little too much for beginners who need to start with basics and then advance to more advanced trading techniques before getting into the philosophy of options.
An often overlooked but excellent set of training tools for options trading with Japanese Candlestick Trading Signals is Stephen Bigalow’s series of options training videos on his website’s store pages.