I receive hundreds of emails a week asking me about trading advice, but one email that I received recently really made me think.
It was from a student at one of the top business schools in the world who wrote me a very passionate and eloquent email about options trading, that it took me weeks to think about how to answer him.
His basic question was how do I learn how to trade options?
He told me he had watched videos, read newsletters, books talked to brokers at Morgan Stanley but still felt confused as ever on how to trade options.
So I wanted to share with everyone what I wrote to him plus some other advice that I have learned over 15 years of trading and working for some of the top hedge funds and research firms.
1) Only trade options with money you can lose, meaning never ever bet the house on an option, use 5% to 10% at max of your trading account for options.
2) Do not follow options tips from newspapers, even the prestigious Barrons, and their nice and creative options writer Steven Sears is not a good mentor. Mr. Sears is a good writer, but he is not an options trader, I have written him at least 6 times about mathematical errors in his options columns and mistakes, he seems to think that you can make more than 100% selling an option, its mathematically impossible, yet the editors allow it… Scary huh..
3) Do not follow option tips from Floor Traders, yes traders who worked on the floor of the CBOE or the NYSE or AMEX exchanges
have traded a lot of options, but their scalpers who pay little if any commission or spread on an options trade, so you will
never be able to replicate their trading technique unless you are on the floor. Moreover 99% of floor traders make their
money off deal flow and spread, very few if any take outright positions in options. So their advice is simply not applicable
to the regular investor.
4) Do not trade options or take options advice from full service brokerage firms, for two simple reasons: Brokers are salespeople they make money regardless if you win or lose on your trade, and more importantly they charge huge commissions as much as $100 per trade. There is no worse place to trade options than at a full service brokerage firm.
5) Do not take options advice from newsletter gurus who spam with you promotions, they have no skin in the game and they have blown out more accounts than they have profitable trades. Remember really good option trades are rare, so anyone telling you they can consistently make money trading options is not being truthful.
So where do you go to learn about options or how trade options, let me share with you the letter I wrote to the young business school student the other night.
It looks like you are on a great path to be a successful options trader.
I honestly think the best way to learn about options is trial by fire. Meaning either paper trade or trade any money you have so you can experience the ups and downs of the market.
Trading is very emotional, you need to see what type of trader you are?
Are you patient and can take drawdowns- then try and use longer dated options where there is a catalyst that could reprice the stock before the option expires. That is how we trade options in our service at The Billionaires Portfolio. But these types of option trades are rare so you have to be very patient.
If you are a short term trader use deep in the money options, 1 to 2 months out maximum and buy calls on popular and market leading stocks (Apple, Google, Twitter, Facebook etc.) after major selloffs and use limit orders and Good Till Cancel Orders. If you don’t know what this is google it and learn it!
Finally there is no magic bullet for trading options, so you have to be flexible and adjust your strategy and temperament to the current market conditions.
Yet options will always be popular, because of the huge profit potential that can be made off a good options trade (100% 500% 1000% and yes many of the greatest hedge fund traders and hedge fund managers started their career and funds with huge options trades that not only made them rich but put them on the map as well.
So stay tuned as I will continue to talk about options trading and strategies on this blog.
President of The Billionaires Portfolio