Trading stock options is a much different game from trading the
underlying stocks. When options are traded for appreciation, it is a
game of leverage, with big risks and associated big returns. One of
the attractions of trading options is that you do not need a large
amount of starting capital. It's also easy to play both sides of the
market by purchasing call options for the upside and put options for
the downside.
Rules of the options game
Remember that in the game of options time is your enemy. If the
market moves against you, then get out of the position and take your
lumps. Save the remaining principal for the next play.
When you play options, you should use stop prices. Because of the
volatility of option prices, it is suggested that you use a principal protect
percentage of 50%, a profit-protect percentage of 75%, and a
trigger percentage of 25%.
Also, watch for sufficient volume in the option to allow for liquidity
when it's time to release the position. Adequate volume would be an
average volume of 100 contracts a day.
Diversify
Because of the risk involved, the principal allocated to option trading
should be limited to only a small portion of your investment capital.
To spread the risk, total assets should, of course, be diversified over
multiple types of investments.
Because trading options is a different game, it is recommended that no
more than 20% of your option trading principal be committed to any
one position. Then, if, as can easily happen, you loose 25% on one
trade, you have lost only 5% of your original principal.
Wait for proper timing
It is not important to be in the market all the time. Unless you have
sufficient information to make an informed decision, wait. When
everything is right, profits will come quickly.
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