Improving Your Trading Skills
When people first start learning about trading options, they are often overwhelmed by the sheer volume of information relating to the subject. However, while there is a fair amount that a beginner should know before getting started, it is really not necessary to learn the whole subject inside out at the outset. It is possible to learn a lot as you go along, increasing both your knowledge and experience at the same time.
Once you become comfortable with the fundamentals and understand how they are applied in practice, you can then start increasing your knowledgebase – and your trading skills – further by learning more about the complex topics. In this section we provide information on a number of such topics, which you can see linked on the right hand side of this page under “Section Contents”.
For more information on everything in this section, please see below. Please note, if you have not yet read the earlier sections of this website (Introduction, Basics and Getting Started) then we would strongly suggest you go through those before proceeding with this section – unless you already have a good understanding of the fundamentals of options trading.
Advanced Terms & Phrases
There are a few advanced terms and phrases used in options trading that, although not essential for the beginner to understand, are very important for anyone looking to expand their knowledge. We have produced a list of those that we believe to be particularly relevant and provided detailed explanations of what they mean in relation to options trading. Some of the phrases included are hedging, open interest, legging, synthetic positions, option pain and rolling.
Please click here for further information.
Volatility & Implied Volatility
Volatility is an important subject that is relevant to pretty much any form of investment, as it basically relates to how much – and how quickly – the price of financial instruments can change. The price of options can be affected quite significantly by volatility, and so it is something that options traders can definitely benefit from understanding. In particular, it helps to be familiar with the differences between statistical volatility and implied volatility, and how it is possible to profit from volatility in the financial markets.
For a complete and detailed explanation on this subject, please read this page.
Understanding Risk Graphs & Risk to Reward Ratio
Risk management is an essential part of options trading, and something that even the most experienced and successful traders have to put some effort into. Like any form of investing, trading options does carry risks and if you don’t control the risks you are exposed to then you are unlikely to be profitable in the long run.
There is not any one correct way to manage risk or any specific level of risk that is right as it ultimately comes down to what you feel comfortable with and what is appropriate for your own circumstances and individual objectives. There are a number of ways in which you can manage risk, and the methods you choose should reflect your personal situation. There are two particular tools that you may find useful – risk graphs and the risk to reward ratio.
Risk graphs are basically diagrams that depict how the potential losses, and profits, that you will be exposed to when entering a position. They can be very useful when deciding whether a specific trade has the right characteristics before going ahead with it. The risk to reward ratio is a fairly simple calculation that helps you determine how the level of potential profits in relation to the potential losses. This can also be used to help you decide whether a trade is right for you.
You can read more about both of these here.
When options were first introduced into the financial markets, the idea of trading them was not hugely appealing to the majority of investors – as there was very little known about how they were priced and it was considered difficult to determine their value. The subsequent development of options pricing models – notably the Black Scholes model – helped changed that perception and ultimately helped them become the popular trading instruments they are today.
Two of the best known, and most widely used, pricing models are the Black Scholes model and the binomial model. Although it is perfectly possible to be successful without using such models, it is a good idea to have at least a basic understanding of what they are and how they work. You can read more about these models on the following two pages.
Auto trading is basically a way to trade options, and hopefully make profits, without actually having to decide what to buy and sell. There are services that you can subscribe to which will make your trading decisions for you and then automatically instruct your options broker to execute them on your behalf. By paying for an auto trading service you can potentially make money without knowing anything about options trading, although this is not necessarily an ideal way to go. There are certain benefits to these services, but there are some disadvantages too.
For more information on what is involved, please visit this page.
An understanding of the five main options Greeks – Delta, Theta, Gamma, Vega and Rho – is pretty much vital for any investor that wants to maximize their profits and chances of success when trading options. These Greeks are values assigned to options that, in theory, show how their price will move according to certain factors such as changes in the price of the underlying security, the time left until expiration, the volatility of the underlying security, and changes in the interest rate.
Although they provide a theoretical indication rather a precise prediction, knowing how to interpret the options Greeks can be incredibly helpful when it comes to forecasting what will happen to the price of an option.
For more details on each of the main Greeks, please click here.