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8 options trading tips

Agriculture.com Staff 11/21/2008 @ 10:51am

Scott Shellady is a veteran options pit trader in Chicago with close ties to his family's farm. He says options are key tools in today's market where outside factors weigh more heavily than ever before.

Scott Shellady is a veteran options pit trader in Chicago with close ties to his family's farm. He says options are key tools in today's market where outside factors weigh more heavily than ever before.

Make sure that you are knowledgeable of the product you are trading. Settlement procedures, margins and nominal values are just to name a few. How does the product you are targeting react to outside pressures and markets? What is the history of the product against other similar products? Open interest, volumes and any fundamental information all go into making yourself understand the product you desire to trade.

How are you best going to express your market view with the options in the underlying that you want to trade? Are your strategies efficient and cost effective? Will they pay off if your market direction is correct? How much do you have to spend versus how sensitive do I want my strategy to be are both key inputs into making your ultimate call.

OK. Now you know your product and have an idea of market direction. You believe that your idea is best expressed with one strategy over another. Why is this the case? Make sure that you have a basic knowledge of the basic strategies and that your idea is expressed as you wish. What happens if the market goes in the opposite direction of my strategy? Is my strategy volatility sensitive? These are the basics that you need to have a handle of before the strategy is elected.

There are definitely better times than others to enter the strategy just like in a futures trade. Am I initiating at the end of my perceived move? If so, it's bad idea. Am I initiating too early? Value and timing are like brother and sister. The better your timing the better chance of better value. In these volatile times I would suggest scale in buying and selling rather than an "all in" attitude. Options are cyclical just like everything else.

Make sure that you have an exit plan. It is just as important to have an exit plan as it is an entry plan. All managers and head coaches go into the game with a plan. Things change along the way but the keys to success are your abilities to improvise while sticking to your original plan. When your profit area is breached, look for an exit. Stay disciplined and do the same when things go against you.

If it was really easy, everyone would be doing it. Remember, these are difficult derivatives in difficult times. The risks are there but can be managed. Be comfortable in your maximum downside and put the strategy together. Enter the market with your plan and stick to it. Remember, you are not throwing something out there willy nilly. You should take comfort in the fact that you have an entry plan and an exit plan. And a good understanding of the risks involved. If you can't stomach the risk you can't stomach the strategy. Stick to the plan you are comfortable with and step back and RELAX. A clear mind is a must.

Everything up until now has been totally focused on you and your strategy. The one outside factor is your executing broker. Now, today, you do have the ability to execute on your own into an electric market with the most widely traded options. However, most of the open interest and volume still occurs in the open outcry environment. As stated in tip #1, you should know where you are able to get your best price. If it is electronic, the execution falls to you. If it is in the open outcry environment then you will need a good broker and executing broker. I would suggest asking for assurances in their knowledge of options and even a conversation with a pit broker. They should be more than will to accommodate after the market is closed. Once you are comfortable with their abilities, elect for tip#7 and relax.

This is to an options trader as a stop is to a futures trader. If the strategy is moving your way, you may want to buy some protection in the form of cheap puts or calls to let you stay in the trade longer. If things are not going well you may be able to buy some puts or calls that will bring your total profitability down but allow you to continue to stay in the trade. Protection is a part of the overall game plan (tip#5) but can be both offensive as well as defensive.

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