Options trading has surged in popularity, with average daily volume across US options exchanges skyrocketing from 29 million contracts in 2020 to over 44 million in 2023. This growth underscores the increasing appeal of options as an investment vehicle.

Navigating the complexities of the options market can be challenging for novice traders. However, by understanding and avoiding common pitfalls, traders can significantly improve their chances of success. This article explores 11 essential tips for new options traders: 

Know the ABC's

Mastering the basics and conceptual clarity in any domain is essential to lay a strong foundation. Understanding the nitty-gritty of the options market helps traders understand what they are dealing with and helps focus on tools that can deal with the volatile nature of the options market. It’s essential to start with the fundamentals. Options are a type of derivative, the value of which is derived from an underlying asset. Each option gives the buyer the right but not the obligation to buy or sell the underlying asset at a specific price, called the strike price, before a pre-determined expiration date. When the right is to buy, it is a call option. When the right is to sell, it is a put option. It is essential to master key concepts such as the Greeks (Delta, Gamma, Theta, Vega, Rho) – the metrics used to describe the effect of changes in market conditions on the options, types of options, and trading jargon such as in-the-money, at-the-money, out-of-the-money options. Having a solid foundation not only helps in interpreting the market dynamics but also helps in making informed decisions. Brokers like public.com have an array of learning resources you can use before you start trading.

Paper-trading is Your Tutor

Starting with paper trading helps you learn options trading without risking real money and apply strategies to understand how options work in different market scenarios. It is one of the key practices in understanding how to make decisions in volatile markets. Platforms like Interactive Brokers and Thinkorswim provide promising paper trading tools that help new options traders refine their knowledge by practically implementing it in real-time market simulations without any financial consequences.

Your Goal Should be Crystal Clear

Everyone in the market trades with a pre-determined objective. New options traders should set their objectives clearly before deciding on strategies that align with their risk tolerance and market outlook. Once the goal is clear, it helps avoid impulsive decisions during market volatility, which in turn helps assess the risk-reward profile of every trade.

Tried and Tested Strategies Always Work

While trying new and exciting trading strategies is tempting, it's crucial to remember the value of tried-and-true methods. To successfully navigate market volatility, it's essential to utilize proven strategies. Some of the most effective strategies for weathering market storms include:

• Cash-secured puts: Selling puts while having enough reserve cash to buy the stock if assigned.
• Vertical spreads: A combination of two options at different strike prices to reduce trade costs and limit trade risk at the same time.
• Covered calls: Selling calls against the underlying asset one already owns to generate income.

Greeks to the Rescue

Greeks have always played an important role in understanding how different factors affect an option’s price. While Vega is known to reflect the sensitivity of the option price to changes in implied volatility, all the other Greek effects are important to analyze the overall implication of the market volatility on the option price. By analyzing the Greeks, i.e., Delta, Gamma, Theta, Vega, and Rho, which indicate the sensitivity of option price to various factors such as interest rate, time, etc., one can understand the potential risks and rewards associated with the trade and can implement their strategies accordingly. For instance, if one expects the volatility to increase, they might implement long Vega strategies like buying straddles or strangles.

Be Practical, Not Emotional

While trading, practicality supersedes everything. One might get too invested in a trade, but it is essential to draw the limiting line; in other words, one should know where to stop. This is where the concept of stop loss comes into the picture. One should always use stop-loss and take-profit levels. This helps one protect their capital and lock in gains quickly. One should always define their maximum loss before entering a trade. One should diversify using different strategies for different options. Risk management is crucial since options are inherently leveraged instruments, and one should use this leverage cautiously to book profits and avoid losses.

Position Sizing is Indispensable

Overleveraging is a common trap that new traders fall prey to, and to avoid this, position sizing is the best method. One should always limit the size of each trade. For starters, one should never risk more than 2% of their total portfolio amount into a single trade. Also, one should focus more on the quality of trades rather than the quantity of trades. By following position sizing, one can ensure that even a series of losses will not lead to a significant depletion of their portfolio.

Monitoring Volatility Metrics is the Essence of Good Options Trading

Volatility is the key factor of options pricing, and understanding its mechanism impedes successful trading. Implicit volatility, which reflects the market’s expectation of future price swings, is considered when it comes to options pricing. Higher implied volatility (IV) leads to higher option premiums and periods of high IV demands for implementing strategies like covered calls and naked puts, as option sellers can benefit from the high premiums. On the other hand, periods of low IV favor the buyers as options become relatively cheaper. While tracking the prices of the underlying assets and various related indicators can give insight into the volatility, tracking the VIX (CBOE Volatility Index) can help understand the market sentiment precisely to understand whether volatility will take the uptrend or downtrend.

Know When to Exit

Entering a trade is easy, but the deciding factor is exiting the trade so that one can maximize profits and minimize losses. For this, new options traders should determine their profit targets and stop-loss levels relating to each trade and consider closing positions as the expiration date is near to avoid time decay. For example, if one sells a put option and the underlying asset increases significantly, one would close the trade early to lock in profits instead of waiting for the expiration date.

Be Aware of Your Surroundings

Many factors drive investor sentiments, showing their effect on the market and, specifically, on price volatility. Volatility is expected to spike around earnings releases, Federal Reserve meetings, or any major geopolitical event. Before entering a trade, one should know the earnings calendar and scheduled economic reports such as GDP, inflation data, and news to anticipate price movements. Most popularly, traders use a straddle strategy before an earnings report as they bet on significant price movements regardless of the direction.

Save Every Cent

Options trading involves a lot of brokerage fees. Some brokers charge hidden fees, too. An active trader should always look for brokers who give them the best deal while trading so they can keep more money with them. Public.com has rebates when you trade on options. That means the cost of trading options isn’t standard regulatory fees. It’s negative!