Drawbacks and Advantages of Options

• Despite the temptation to see options as a quick path to riches, traders of options should see options for what they are: risk-reducing instruments, in terms of both strengths and weaknesses. Whittled to their most basic, options give you the right to buy or sell an instrument, such as a stock, at a future time and future price. As the option wastes away until its expiration date, you can do a number of things: exercise the option, sell the option or cancel the obligation (if you are selling). Making profits is certainly possible with options, but it is not every trader's goal: Some traders just want insurance against unfavorable price moves. For a relatively small initial premium, you can place yourself in a position to trade advantageously in the future. Options require less money than owning stocks, yet due to their volatility, more money can be made per trade. On the flip side, volatility must be closely monitored; moreover, you can lose your money if you do not sell it before it expires. There are usually only a few months in the life of an option, however, options allow you to play the market up or down, offering great flexibility.
  
  

Limit Losses

• Money management is the due diligence part of trading options or any investment vehicle that seems to border on drudgery. It is not fun, and it does not embody your trading ambitions. However, limiting losses is a crucial part of trading, because it prevents your entire portfolio from getting wiped out. This might involve setting your profit/loss targets before you trade and using stop orders where appropriate. Other measures include using statistical values, known as options Greeks, to alert you when to trade and when to exit. By controlling your losses, you ensure that there will be more days to trade profitably.
  
  

Start With Simpler Options Strategies First

• Although many beginning options traders choose to start out buying calls or puts, the likelihood of making consistent money from that strategy is small. Other strategies are easy to understand, involve less risk than owning a stock, and carry limited risk. Despite their imposing names, condors, credit spreads, collars and covered call writing are good initial options with which to get your feet wet. An example of the latter is buying 100 shares of IBM and selling one IBM January 110 call. You keep the premium from the call and even with a drop in stock price, you are better off than just owning the shares. However, do not let covered calls inflate a false sense of security, because losses can be substantial.
  
  

Avoid Overtrading

• There is the temptation, especially when selling inexpensive options, to overdo and trade too many options contracts. New traders, in their excitement and desire to see action, will accrue many more contracts than is healthy from a risk standpoint. Do not place your portfolio in jeopardy by amassing options contracts just because they are cheap and you have high hopes for them.