Identifying Opportunities to Trade Options
If you have been reading through this guide in order to help you get started with options trading, you will know all about the initial preparation required and how to choose a broker. You''ll also have an understanding of trading levels and how they can affect your ability to use certain strategies.
At this stage it's time to start thinking about how you are going to find opportunities to trade. You could know absolutely everything there is to know about options trading, but such knowledge is only useful if you are able to actually put it all into practice and identify opportunities to make some profits.
Even though options trading is really quite complex, anyone that is prepared to spend time learning the subject can ultimately be successful. However, knowing how to trade options isn't enough by itself; you need to know how to make money out of it. This takes hard work and commitment because, you will have to put in the required effort in order to find the right opportunities and then make the appropriate transactions.
If you can do that consistently, then you will almost certainly achieve your goals. On this page we look at how you go about identifying potentially profitable opportunities for trading options.
- Which Underlying Assets?
- Carrying Out Research
- Fundamental & Technical Analysis
Which Underlying Assets?
Although options contracts are assets themselves, they are actually derivatives that derive their value from the underlying assets which they relate to. Options contracts can be bought and sold on a wide range of underlying assets that include stocks, foreign currencies, commodities, and indices.
This makes options trading a very flexible form of investing because, you can make investments on many different financial instruments just by buying and selling options contracts. This means that one of the first things you need to think about when you are looking for potential options trading opportunities is exactly which of these financial instruments you want to include.
We should be clear that you don't need to decide to trade only stock options, or only forex options, or only index options. You can buy and sell as many different types of options as you feel comfortable with. However, you do need to think about how you are going to be researching potential trades and how you'll be identifying suitable opportunities.
If you decided that you were going to consider all kinds of different underlying securities, then you would be giving yourself the best chance of finding opportunities because of the wide range of possibilities. You would need to be prepared, though, to carry out a lot of research into different financial markets which could be very time consuming and it could actually make it very difficult to find the number of opportunities as you would like.
Alternatively, if you decided that you were only going to trade stock options based on stocks in a particular sector, then you would be able to focus your research specifically on publically listed companies that operate in that area. You may end up becoming an expert in that field and be much more adept at identifying related opportunities based on this expertise.
The downside, of course, to taking such a limited approach is that you may be missing out on lots of other opportunities in different sectors and markets that you aren't even looking at.
There really is no right way, or wrong way, to approach this aspect of identifying opportunities and we wouldn't offer any specific advice in this regard. All we would suggest is that you take the time to consider which underlying assets you want to include and then it's ultimately down to what you feel comfortable with and what you think will give you the best chance of success.
If you do have strong knowledge about a particular sector or market, then it would make sense to utilize that knowledge, but there is also nothing wrong with taking a broader view either. You may decide that you don’t want to research and analyze the underlying assets of options, but would rather study the price movements of the options contracts themselves and trade accordingly.
Carrying Out Research
The advent of the intent and online technology has affected trading and investment in more than one way. Not only has it resulted in online brokers, which make the whole process of buying and selling of financial instruments much easier, it has also made information relating to financial instruments much more accessible.
The internet provides a virtually limitless supply of information that can be used for research purposes, and this really is invaluable to investors. It's essential to start checking the exchanges to get up to date quotes and to follow international news that can affect the markets. Even getting financial reports on publically listed companies is an important thing to do. The internet is a rich source of facts, statistics, and figures that can help immensely.
Of course, gathering information is only one part of carrying out research for trading purposes. The real skill is in knowing what information to look for and then knowing how to interpret it. This is a skill in itself, but it's a skill that can be easily developed over time with plenty of practice.
If you are prepared to dedicate a decent amount of time to carrying out research and analyzing what you find then you really will give yourself a much better chance of success when it comes to finding potentially profitable opportunities.
Fundamental & Technical Analysis
Fundamental analysis and technical analysis are the two main methods used by investors and traders to analyze information and help determine what trades and investments to make. Although they are both essentially used for the same purpose, they are very different in the way they are used.
Fundamental analysis is basically about collecting as much information as possible relating to a specific security and then analyzing that information to determine the true value of that security and how it relates to its trading price.
For example, if you want to carry out fundamental analysis on a stock in a particular company, then you would study a number of aspects of that company such as their current financial strength, their earnings reports, the quality of their management personnel, and their competitive edge in the market place. By doing this, you could get an idea of whether the stock was undervalued, overvalued, or priced right in relation to its true worth. This is somewhat simplified, but it gives you an idea of how fundamental analysis is used.
Technical analysis is based around using past data to predict future movements. It involves studying and analyzing charts and graphs depicting price and volume, with a view to finding patterns that could reveal trends that are likely to be repeated. The theory is that by following those trends you can make accurate forecasts about how a security is going to move in price over a given period time. Again, this is a fairly simplified view of technical analysis, but it's a reasonable overview of what is involved.
Both fundamental analysis and technical analysis are typically used by investors in stocks, but they have their use in options trading too. The general idea is that you would use these methods to help you get an idea of how you would expect the price of financial instruments to move, and then trade the appropriate options contracts to benefit from those moves.
Neither fundamental analysis nor technical analysis can really be considered better than the other one as there are a number of factors to take into account. To some extent it comes down to personal preference; if you feel more comfortable using one of the techniques for your analysis, or have a particular aptitude for it, then it obviously makes sense to use that technique. You may prefer to use a combination of both, or use fundamental analysis in some circumstances and technical analysis in others.
It's worth nothing, though, that options trading is often about taking advantage of short term price movements rather than anything else. Fundamental analysis can help you gain an understanding of the inherent worth of a security, and it is commonly used by long term investors to invest in undervalued stocks that should go up in price over time. However, it doesn’t necessarily help you predict price movements in the immediate term.
Technical analysis can, which is why options traders are probably more likely to benefit from using technical analysis: particularly those using a day trading style and making several short term trades on a daily basis.
Another thing to consider when you are identifying potential trades is how much capital is required and how much risk is involved. Managing your budget and your exposure to risk is an important part of options trading, and we cover more on that subject on the next article in our guide – Risk & Money Management.