Basic Option Strategies for Rookies

May 28, 2010

Basic Option Strategies for Rookies

Most people adopt an attitude that tells them that investing and accumulating wealth is easy.  Investment club members have the advantage of entering investing with the point of view that investment education is important.  I’ll continue on that path by explaining what an option is and how an option works before we consider making a trade.

 That’s especially true with options because they have characteristics that are far different from other investment vehicles.  Limited lifetime is one that is immediately obvious.   Thus, it’s important not to get ahead of yourselves when preparing to trade options.  If you are fortunate enough to be in a club with experienced option traders, you have people with whom you can discuss any questions that arise via these posts.  And if you have no such person, please feel free to send questions to me:

Today, I’d like to take a jump ahead and tell you a bit about some of the strategies that I’ll be recommending.  However, the basics come first and I hope you have the patience to wait before beginning to trade.  I have no way to know the knowledge level of most readers, but a preliminary poll requested that I start at the beginning.  I’ll do that, beginning with the next post.

This introduction is offered to provide some insight on what lies ahead.  Next week I plan to get down to basics and help you learn how options work.  I’m hoping to receive feedback between now and then to give me an idea of what topics you want to see covered.

I thank those who already participated in the initial poll.

Except for a special situation in which you prefer to own shares of stock, all recommended strategies are going to have one characteristic in common: limited risk.  I will discourage you from taking unlimited risk.  In fact, managing risk is going to be a recurring theme in my contributions.

To limit risk, every time one option is sold, another is bought.  That means we are going to be concentrating on ‘spreads.’  A spread is nothing more than a position of two (or more) options as opposed to a single option. 

I will discourage purchasing options as a speculative play, but will recommend buying a certain type of call option as a replacement for buying stock.  Because investment clubs always buy stock, this is a method you will be able to consider using.

But first things first and it’s time to begin at the beginning.  Next Monday.

Mark D Wolfinger
Expiring Monthly: The Option Traders Journal