When Should Someone Start Options Trading? (Simple Answer)
If you’re thinking about adding to your income with options, you might wonder when it’s a good time to start trading.
Unfortunately, there’s no easy answer to that question.
There are, however, guidelines that you should follow. In this guide, I’ll go over a few of them.
Step 1: Get out of Debt
The old Motley Fool rule about when to trade stocks also applies to options. First, get out of debt.
Specifically, pay off your car loans and credit card balances.
Why? Because you’re already losing money with those debts.
Think about it: if you’re paying an 11% interest rate on a $3,000 credit card balance, then you’re currently losing $330 per year ($3,000 x 11% = $330).
You can stop that loss by paying off the debt.
If you have some extra cash on hand, resist the temptation to deposit it in your online brokerage account and instead use it to pay off those outstanding loans.
There’s a caveat to the “get out of debt” rule, though. You don’t have to pay off your mortgage or college loans before you start trading options.
That’s because those loans are investments in assets that tend to appreciate in value over time.
Take your house, for example. Real estate typically goes up in value over the long term.
Similarly, the amount you invested in your education (your college loans) proves worthwhile as your income increases from year to year.
There are exceptions to those rules, of course. Sometimes real estate drops in value (that happened in 2008). Sometimes you take a hit in income.
But, generally speaking, investments in real estate and education tend to pay off over the years.
That’s why mortgages and college loans are considered examples of “good debt” while car loans and credit card balances are considered examples of “bad debt.”
Bottom line: get out of bad debt before you start trading options.
Step 2: Don’t Learn the Hard Way
Once you’ve eliminated your bad debt, you’re still not quite in a position to trade options. You have to educate yourself first.
Even if you think that you’re ready because you’ve traded stocks in the past, you’re probably not ready.
Trading options is completely different than trading stocks.
Although you need to understand the stock market before you trade options, you also need to understand quite a bit more.
Begin by learning the basics. Understand the difference between call options and put options. Learn about contract expiration dates and strike prices.
Once you understand the basics, then it’s time to meet “the Greeks.”
When you study those Greeks, you’ll discover that you need to learn something else before you trade options: basic statistics. At a minimum, you should understand probabilities and standard deviations.
If this is all beginning to sound complicated, it should. Options trading is for people who dig deep into the stats to determine the most favorable trades.
Traders who ignore those stats often get burned.
Once you’ve mastered the basics and understand the Greeks, it’s time to look at the various options strategies.
As is the case with stocks, you can go long or short on options. However, you can also go much farther.
Options give you the ability to place multi-leg orders. Those are trades that involve multiple positions (or “legs”) in a single order.
For example, you can buy a call option at one expiration date and strike price while selling another call option at the same expiration date with a different strike price. That’s called a vertical spread.
Several options strategies rely on multi-leg orders to generate a positive return. Among them:
- Iron butterflies
- Iron condors
There are also different “flavors” of those strategies. When it comes to spreads, for example, there are horizontal spreads and vertical spreads.
Within the world of vertical spreads, there are bear call spreads, bull call spreads, bear put spreads, and bull put spreads.
Each strategy is designed to make money only under a specific set of circumstances. That’s why you need to study the various strategies so that you know when they’ll put cash in your pocket based on your outlook for the underlying stock.
If you’re looking for a “crash course” in options trading and an overview of the various strategies, feel free to browse through our Options Strategy Lessons here at InvestingDaily.
Step 3: Practice Makes Perfect
This third step is really a continuation of “Don’t Learn the Hard Way.” Do some practice trading before you invest real money.
After you’ve followed the advice above and thoroughly educated yourself in options, you might think that you’re ready.
Spoiler alert: you’re probably still not ready.
Don’t take that personally. Everybody needs to do some practice trading before doing the real thing.
There are lessons you’ll learn when you trade in the financial markets. It’s better to learn those lessons the easy way rather than the hard way.
Fortunately, there are trading platforms that allow you to practice trade. You can set up a pretend portfolio and start trading stocks and options without risking any of your hard-earned cash.
Then, you can see if you’re profitable with your trades as time passes. If you’re not profitable, take some time to determine what went wrong so that you can avoid making those mistakes in the future.
You might be reluctant to do any practice trading because you’re afraid that you’ll miss some opportunities to make real money.
That’s true, but you’ll also miss some opportunities to lose money.
And it’s not terribly unusual for novice options traders to lose money with their first trades.
P.S. Never Stop Learning
You’ve never “arrived” when it comes to options trading. There’s always something that you can learn from an expert trader or a blog post.
Even when you’ve educated yourself and practiced trading to the point where you’re confident in your abilities as a trader, keep learning.
Follow this blog. Read books by successful traders. Listen to podcasts. Participate in webinars.
Every day, strive to make yourself a better trader than you were the day before.
Then, pass on what you’ve learned to novice traders.