I have discussed the many advantages and a few disadvantages of options spread trading in a series of articles on . At this point, the reader might contemplate whether to get involved in options spread trading. The risks of an option being exercised, the additional commission expense or the additional complexity might not be worth for some investors.
I have traded options, stocks, and commodities for nearly two decades. Yet, I was still hesitant to enter options spread trading for a good part of my career. Part of the reason for my hesitance was the high commission structure that used to be prevalent in the options marketplace. However, high commissions are no longer a factor.
The real reason why I stayed away from option spread trading was that I thought options spread trading was more complicated than I wanted to manage. I was also very hesitant to expose myself to risk associated with selling calls or puts. In some cases, the downside might be virtually unlimited or I might be assigned or have an option exercised.
After studying options extensively, I got my feet wet on the long side and then on the short side. I soon realized that I was exposing myself to continued risk by staying away from spread trading. Engaging in only basic option trading, I continuously risked lower-probability profit trades without proper hedging. I was essentially forced into spread trading to manage risk.
Taking the plunge into option trading
Once I got involved and learned the ropes of spread trading, I discovered that I did not need to master every type of spread trade. Some option spread strategies are incredibly complicated and are useful only if you have exhausted all alternative investing strategies. I trade options to make a good, consistent return on trading investments month after month, year after year, decade after decade. Options spread trading is one of the best vehicles for doing just that.
I learned that to be a strong options trader, I needed only the basic strategies in my options trading toolkit. All I needed were the basic strategies for bullish, bearish and neutral positions on options. Once you master the basic strategies and learn the essential terminology, you can adapt to all other varieties of options strategies with ease.
There are many option trading strategies and many different names for those strategies. However, I will show you the basic strategies that a novice spread trader needs to handle virtually any kind of market. I will examine a few strategies in detail. Once you understand those strategies, you can apply the same basic principles to almost any type of option trade. I will not discuss the extremely advanced strategies. Using these complex strategies might return a few additional points on your rate of return. However, the additional gains are usually not large enough to offset the increased costs for the additional trades.
Proceed with caution
Before I get into the details of specific strategies in other articles, here are few cautionary statements. As with almost all investments, any money that you invested in options must be money that you can afford to lose. This warning goes double for the trades where you are selling the rights for another party to demand delivery of some security or money from you — including selling calls and puts.
This means that options trading — especially options spread trading — is not for everyone. If I buy only calls or puts, I am never exposing myself to unlimited risk. However, I am also exposing myself to more risk than is necessary. Every trader must understand that these strategies will only minimize risk. The only strategy that eliminates all possible investment risk is staying out of the market completely. As long as you understand that, we are all clear to proceed into option spread trading.
Some traders might decide that the potential risk in option spread trading is too great for them. I would advise those traders to reevaluate whether they should trade in options at all. I believe that anyone who wants to trade in the options market, should consider seriously using option spread trading. The advantages of option spread trading will generally reduce the risk of loss. Avoiding large losses is important even more than obtaining every bit of profit. If you are willing to learn option trading basics and if you have the discipline to execute the strategies, options spread trading is a fantastic way to minimize potential losses.
Billy Williams is a 25-year veteran trader and author. For a free strategy guide, “Fundamentals for the Aspiring Trader”, and to learn more about profitable trading, go to www.stockoptionsystem.com.