Options can be a menacing trading practice. Once you think you have it figured out, it shifts. Like any investment, there’s going to be some sort of gamble. Although viewed by bitter traders as confusing, risky and unprofitable at times, options can produce monstrous gains that can far outweigh the risks if played right.

Trading options is all based on anticipation. Yet with the volatility of the market, trading can be very frustrating with the market being unpredictable. There are several strategies and tips that you could practice that will increase your odds…

Here are 10 helpful tips that will contribute to minimizing risk and pull in huge profits when trading options:

10) Develop a game plan

How practical is this statement in life? You must always have a game plan when trading or investing. Otherwise, you’ll most likely trade irrationally and insensible and end up losing more than you had hoped. Developing a plan and strategy will have better odds than trading randomly. This should always be your first step to investing.

9) Select a good broker

Even with today’s easy access to a variety of resources, trading options are still very difficult to do on your own. Unless you’re a pro at trading, it would be to your best interest to select a brokerage firm for guidance. There is a plethora of different services out there offering different products. Shop around and learn their tract records. Make sure you choose one that’s compatible with your objectives and personal requirements. Remember, these are the people investing your money. Also, be aware of commission fees.

Evaluate yourself

What are you trying to accomplish? How much money do you hope to make? How much can you take in losses before it affects your life? These are simple questions you should ask yourself when deciding to trade. Evaluating yourself will help you reduce of risk as well as help you plan your trading.

7) Know and understand the market

There are so many strategies and tactics when buying or selling options that you could trade in all market trends. Whether the market is bullish, bearish, or neutral, understand the trends and correlate it to your trading strategies.

Different markets will require different trading strategies. For example, you’re going to want to buy calls in a bullish market and sell calls in a bearish market.

News and press releases will have an impact on a stock price. Don’t buy from what sources are saying despite if they’re true. Chances are you’ll get in too late. Wait for a favorable price.

6) Separate and dilute your capital

There’s no other word more commonly used when preventing risk than diversification. This practice is so widely used in all investing practices. Like stocks, buy in several different sectors and equities to minimize risk.

Never trade with money needed for future obligations. Have a separate portion of your capital for trading options. The worst thing you would want is to lose your mortgage payment or retirement savings on one single sour trade.

5) Don’t get out early

You may have just had a few consecutive losses on several trades and you now have the mindset that all your trades will continue to negatively streak. Initially, you panic and tell yourself to get out to minimize your losses. That might be the worse thing you could do. If you get out too early, you could lose out on potential huge gains. In options, huge gains are what overcompensate any losses.

4) Don’t hold too long

Pay attention to the expiration date. Time value is one of the most important factors when trading options. Having the entire option expire and losing its value would be bad. Understand that options decay over time. If you feel it’s time to sell, sell. It’s better to take a small loss than losing everything.

3) Secure your gains

Losing money right after you make it is a horrible feeling. With the volatility of the market, it’s easy to see a stock jump one week and then drop the next. If you don’t decide to sell after a stock is up in anticipation that it will continue to increase, a simple way to secure your gains is by setting up a trailing stop. A trailing stop is a stop whose price you raise as your profits grow. This will help you lock in any gains you make.

2) Establish a break-even point

A break-even point is the price at which the underlying instrument must shift by the expiration date, to produce an intrinsic value equal to the price you paid when you purchased the option. Defining a break-even point will ultimately help you tell whether the stock is worth selling or buying.

To find the break-even point, use the strike price and premium. If you’re buying a call, add the premium to the exercise price. If you’re buying a put, subtract the premium to the strike price. For example, if you were to buy a $40 put contract on Company XYZ for 5 1/2, the break-even point would be $34.50.

1) Research

This is a no brainer. Researching is the most useful and important thing to do when trading in anything. Pay attention to market trends. The best way to beat the market is to know the market. Great research is the key to consistent success in the market. Outside sources like your broker, news, TV etc. are great ways for information, but it all comes down to you. Your own personal information is more valuable than any other resource.

Options can be confusing and frustrating at times. Yet options can produce enormous gains. The collaboration of these 10 highlighted tips will help you increase your chances of making profits while minimizing risk when trading options.

Regards,

Mark Louie
July 22, 2008

Option Investing Tips was originally featured in the Penny Sleuth.

“I will have realistic expectations. Even the best of traders are only human, and can look their worst when losing. I don’t expect to have only winning trades and realize that losing trades are just as integral a part of my performance as are the winners.

“I realize that an investor’s emotions can be his or her own greatest enemy during drawdown periods. I will not allow myself to be victimized by my emotions like so many other investors. I refuse to be part of the herd!

“I will think with my head and not my heart! I will stick to my original investment game plan that I agreed to when I opened my account. I will have patience, think long term, and stay tough! I’m not a fair weather investor.”

Those words are the investor’s oath of our very own “Maniac Trader,” Kevin Kerr. Kevin, a Minnesotan like myself, has been investing in commodities options and futures for 17 years now.

As you can see, the oath mentioned above can be very difficult to live by, especially in options.

Why would someone play the options market? Simply put, options trading provides a very beneficial risk-reward scenario. Unlike futures, you can’t lose any more money than you put in, while the possible profit is limitless.

Just look at the wheat market, for starters. The price of wheat has more than doubled on a year-over-year basis. The two main reasons for the price move was the poor weather we had this season, and the fact that the most acreage since World War II was dedicated towards corn production. This results in less acreage for other crops, like wheat. The people who were invested in wheat options made an absolute hauling.

Let’s just look at one of Kevin’s many triple-digit gain options trades. The Maniac Trader’s July 2006 silver $13 call made a 400% profit. Oh yeah, did I mention that the trade was only open for 34 days? On one silver contract that cost $750, in 34 days, you could have sold it for $3,750. Not bad.

So before we dig in, let’s look at some of the basics of the options market.

First and foremost, an option is a contract that gives the buyer the right, but not the obligation, to buy or sell a specified quantity of a commodity or other instrument at a specific price within a specified period of time.

The two basic transactions in the options markets are calls and puts. Essentially, a call is the right to buy a contract at a specific price and date, while a put is the right to sell a contract at a specific price and date.

Some other terms that you will consistently hear in discussions regarding options are “in the money” and “out of the money.” This is a reference of the strike price, or option price, compared to the price that the commodity is currently trading at.

If the strike price is above the current price of the option, it is considered out of the money (meaning a loss), and the opposite is true for an option being in the money (meaning a gain).

But what do you look for when trading options?

The markets for energy are ever growing and prevalent in today’s global economy. There are definitely huge profits to be made in the sectors of natural gas, crude oil and heating oil. But these markets are much more complicated than you think, so what do the “professional traders” watch in these markets?

Starting off, he keeps a keen eye on the Energy Information Agency (EIA) and the American Gas Association’s (AGA) weekly reports of crude oil and natural gas supply and stock levels.

He also checks extensively into global supply and demand fundamentals. An imbalance of supply and demand can lead to an awesome opportunity for profits in these volatile markets.

Don’t forget about geopolitical risks, either. Discussing whether the tough rhetoric on Iran is just that, can be one of the most important factors regarding whether or not we might see a dramatic price swing one way or another.

If that seems a little overwhelming to digest, I haven’t even discussed interpreting if any, or all, of the above-mentioned factors have been already priced into the markets. This might be one of the toughest things to do. The reason being that it almost takes an intuitive sense one can only acquire after 17 years of trading commodities.

I’m not trying to intimidate you, but the point I really want to make is that although there is immense profit potential, it’s not as easy as connecting the dots. So how do the “experts” do it?

Maybe it’s his Midwestern heritage, but Kevin Kerr knows his agricultural commodities. Reading weather report after weather report and crop report after crop report can be repetitious and boring, but that’s exactly what it takes to make money in these types of investments.

Kevin understands the seasonal trends, and how a late drought or early frost will affect the prices of certain commodities.

He knows the differences between cotton crops and why soy oil tends to follow the price of crude.

Also, one of the most important notions of agricultural goods is the growth of developing nations and the desire of their citizens to increase their quality of life. The result of this trend is increased demand in all foods, especially meat.

Just look at China’s food inflation. In August alone, it rose 6.5%. The main increase was that of pork which rose 49% due to shortages of the “other white meat.” These stories are consistent from China to India to Brazil.

All of these factors and more have to be considered when trading commodity options. So even with the profit potential, it’s still a big job.

Regards,
Nick Jones
September 24, 2007

P.S.: Honestly, it really is a full-time job to trade these commodity options. But when you can see gains like 60% in two days, 72% in eight days and 100% in 12 days, it’s worth it.

Unfortunately, most people don’t have that kind of time. So, to help people trade these, we got one of the best, if not the best, in the industry — Kevin Kerr himself — to head a special investment service dedicated to only commodity trading. It’s called Resource Trader Alert.

Penny Stock Commodities was originally featured in the Penny Sleuth.