Options are a great resource, but they pose a danger if you don’t approach them right. They are a powerful trading tool, but too many people treat them like a casino bet. It makes sense why this happens: options have a set amount that you risk, and if your prediction is correct, then you are rewarded with a fixed rate of return.
You certainly can trade options like this, but you shouldn’t. Unlike a casino bet, you can gain a very strong understanding of what is going to happen and use that to your advantage when making a decision. You can trade all sorts of assets through a broker. They typically offer stocks and indices, currency pairs like what are offered at a Forex broker, and commodities. Let’s go over an example of how to make the decisions that will help you in a smart and profitably way.
You want to trade the EUR/USD pair, and your analysis tells you that it is going to go up in price. You take out a 15-minute call option for $20, and the rate of return that you will get if you’re correct at expiry is 78 percent, or $15.60. If you’re wrong, then you lose $20. If you rely on random chance, just like what you would find at a casino, you will be right half of the time and wrong half of the time. Over the course of two trades, you’ve lost $4.40. Over the course of 20 trades, you’ve lost $40.40. There’s no way that you can overcome that if you rely just on random chance.
Beating the Broker
Just like Forex brokers have the spread that you need to beat, options brokers have this gap that needs to be overcome between what you earn and what you lose. The simplest way to overcome this disadvantage is to have a firm idea of your chances of success on a trade. When you can look at a potential trade and know that you have a 60 to 70 percent chance of success, then you can adjust the amount of cash you risk to reflect that. We’ll look at risk management in a little bit, but the basic idea to keep in mind is that you should risk less when you have only a slight chance of profits, and your cash levels should increase when you have a better chance of success.
Think Long Term
There are two long term approaches to options trading. The first revolves around your account. You have only a limited amount of money, and you don’t want to overstep that amount and risk too much on a single trade. If you have $1,000 in your account, risking more than $20 on a trade is usually a bad idea. You should never risk more than 2 percent or so on a single trade. That will preserve your account through the rough times and set you up for good trades going into the future.
The second thing to keep in mind is that each trade you make needs to have a long term focus. Even if you are trading 60-second trades, they are each building off of the other. One trade might be difficult to predict, but over the course of months and years, trades can be given a sort of predictability. You will figure out that you can predict trades with a 65 percent success rate, for example. When you plug this number into your overall strategy, you can find which rates of return will be helpful to you, and which you should stay away from.