Options are one of the most versatile instruments in the financial markets. Their flexibility allows you to leverage your position to boost returns, manage risk by using them for hedging, or to make profit from upside, downside and sideways movement in the market.
How to Become an Options Trader
Despite its many benefits, options trading carries substantial risk of loss, and it is very speculative in nature. Not everyone can become a successful options trader. Like any other business, becoming a successful options trader requires a certain skill set, personality type and attitude. This article will help you understand the 10 characteristics required on how to become a successful options trader.
1. Be Able to Manage Risk
Options are high-risk instruments, and it is important for traders to recognize how much risk they have at any point in time. What is the maximum downside of the trade? What is the implicit or explicit position with respect to volatility? How much of my capital is allocated to the trade? These are some of the questions traders always have to keep in their minds.
Traders also need to take appropriate measures to control risk. In particular, if you are a short-term options trader, you will regularly come across loss-making trades. For example, if you hold a position overnight, your bet may go bad because of adverse news. You need to be able to minimize the risk of your positions at any time. Some traders do so by limiting their trade size and diversifying into many different trades so all their eggs aren't in the same basket.
An options trader also has to be an excellent money manager. They need to use their capital wisely. For example, it wouldn't be wise to block 90% of your capital in a single trade. Whatever strategy you adopt, risk management and money management cannot be ignored. (For more, see: Measuring and Managing Investment Risk.)
2. Be Good With Numbers
While trading in options, you are always dealing with numbers. What's the implied volatility? Is the option in the money or out of the money? What's the break-even of the trade? Options traders are always answering these questions. They also refer to option Greeks, such as the delta, gamma, vega and theta of their options trades. For example, a trader would want to know if his trade is short gamma. (For more, see: Getting to Know the "Greeks.")
3. Have Discipline
To become successful, options traders must practice discipline. Doing extensive research, identifying opportunities, setting up the right trade, forming and sticking to a strategy, setting up goals, and forming an exit strategy are all part of the discipline. A simple example of deviating from the discipline is following the herd. Never trust an opinion without doing your own research. You can't skip your homework and blame the herd for your losses. Instead, you must devise an independent trading strategy that works in order for it to be a successful options strategy.
While formal education in the form of higher degrees can be associated with elite traders, it is not necessarily the case for all. But you must be educated about the market. Successful traders take time to learn the basics and study the market—various scenarios, different trends—anything and everything about how the market works. They are not usually novices who have taken a three-hour trading seminar on “How to get rich quick trading,” but rather take the time to learn from the market.
4. Be Patient
Patience is one quality all options traders have. Patient investors are willing to wait for the market to provide the right opportunity, rather than trying to make a big win on every market movement. You will often see traders sitting idle and watching the market, waiting for the perfect time to enter or exit a trade. The same is not the case with amateur traders. They are impatient, unable to control their emotions, and they will be quick to enter and exit trades.
5. Match Your Trading Style With Your Personality
Each trader has a different personality and should adopt a trading style that suits his or her traits. Some traders may be good at day trading, where they buy and sell options several times during the day to make small profits. Some may be more comfortable with position trading, where they form trading strategies to take advantage of unique opportunities, such as time decay and volatility. And others may be more comfortable with swing trading, where traders make bets on price movement over periods lasting five to 30 days.
6. Read and Understand News
It is crucial for traders to be able to interpret the news, separate hype from reality and make appropriate decisions based on this knowledge. You will find many traders eager to put their capital in an option with promising news, and the next day they will move on to the next big news. This distracts them from identifying bigger trends in the market. Most successful traders will be honest with themselves and make sound personal decisions, rather than just going by the top stories in the news. (For related reading, see: Market News That Seems Promising But Isn't.)
7. Be an Active Learner
The Chicago Board of Trade recently reported 90% of options traders make losses. What separates successful traders from average ones is successful traders are able to learn from their losses and implement what they learn in their trading strategies. Elite traders practice…and practice some more until they learn the lessons behind the trade, understand the economics behind the market and see the market behavior as it is happening.
The financial markets are constantly changing and evolving; you need to have a clear understanding of what's happening and how it all works. By becoming an active learner, you will not only become good at your current trading strategies, but you will also be able to identify new opportunities others might not see or may pass over.
8. Be Flexible
You cannot stake a claim on the market but must go with the market or leave it when it is not the type that suits you. You must accept losses occur and that it is inevitable that you will lose. Acceptance rather than fighting the market is paramount to understanding, clarity and finally winning.
9. Plan Your Trades
An options trader who plans is more likely to succeed than one who operates on instinct and feel. If you don't have a plan, you will place random trades, and consequently, you'll be directionless. On the other hand, if you have a plan, you are more likely to stick to it. You will be clear about what your goals are and how you plan to achieve them. You will also know how to cover your losses or when to book profits. You can see how the plan has worked (or not worked) for you. All these steps are essential to developing a strong trading strategy.
10. Maintain Records
Most successful options traders keep diligent records of their trades. Maintaining proper trade records is an essential habit to help you avoid making costly decisions. The history of your trade records also provides a wealth of information to help you improve your odds of success. (For related reading, see: Make Better Options Trades With the Average Monthly Range.)
The Bottom Line
Top options traders get a thrill from scouting and watching their trades. Sure, it's great to see a pick come out on top, but much like sports fans, options traders enjoy watching the whole game unfold, not just finding out the final score. These characteristics will not guarantee your success in the options trading world, but they will definitely increase your chances at it. (For related reading, see: Trader or Investment Banker: The Best Job for You.)