Investment Tips Keeping Option Trading Simple

One very intelligent rule when it comes to investing is to always keep the investment problem as simple as possible. Don't let someone talk you into getting fancy and speculating in strips, straddles, and spreads.

What is a strip? A strip is a form of conventional option that couples one call and two puts on the same security at the same exercise price with the same expiration date. The premium is less than it would be if the option were purchased separately.

What is a straddle? A straddle is either long or short. A long straddle is a long call and a long put on the same underlying security at the same exercise price and with the same expiration month. A short straddle is a short call and a short put on the same security at the same exercise price and with the same expiration month.

What is a spread? A spread is a purchase and sale of options of the same class (class refers to time).

It is difficult enough to just pick a stock or an option that is going up. If you confuse the issue and start hedging (being both long and short at the same time), you could, believe it or not, wind up losing on both sides. If you think a stock is going up and it is the right time to buy, buy it or purchase a long-term option and put your order in at the market. If it's time to sell, sell at the market. Option markets are usually thinner and not as good as markets for a stock on the New York Stock Exchange. The way orders on the options exchanges are executed is even different.

Most amateur option traders constantly place price limits on their orders. Once they form the bad habit of placing limits, they are forever changing their price restraints as prices edge away from their limits. It is difficult to maintain sound judgment and perspective when you worry about changing your limits by points. In the end, you'll get two or three executions after tremendous excess effort and frustration. When you finally pick the big winner for the year, the one that will triple in price, you'll lose out because you put in your order with a point limit below the actual market price.

You never make big money in the stock market by eighths and quarters. You could also lose your shirt when your security is in trouble and you fail to sell and get out because you put a price limit on your sell order. Your objective is to be right on the big moves, not on the minor fluctuations.

The secret to making money in options doesn't have much to do with options. You have to analyze and be right on the selection and timing of the underlying stock. Therefore, you can select the best possible stock at the best possible time. If you do this and are right, the option will go up along with the stock, except the option should move up much faster due to the leverage.