Stock option trading offers the skilled trader more potential for making a fortune option trading than almost any other form of online trading in todays market. The degree of controlled risk along with superior leverage allows a knowledgeable option trader the chance to make huge profits but an aspiring option trader must have a solid foundation of education about what makes up a sound option trading method in order to have a long term success at option trading. There are five essential keys that any option trader must understand when developing a winning stock option system.
First, you must understand the degree which time affects the premium of the option you are considering trading. There are two parts you must consider when factoring time into the stock option trading decisions. The first thing that you must take into account is the intrinsic time left on an option. Since options have a limited time period of anywhere from 30 days to several year depending on the particular option that you bought you must be sure that you purchase the correct option containing enough time on it to insure that time decay doesnt erode your investment away before your position has enough time to be profitable.
The second skill of trading options profitably is factoring time into your trading system in relation to trading a particular stock option and knowing the statistics of your option trading methodology or option trading setup by knowing the average holding period of a trade signal. If your average holding time for an option trade is seven days then you dont want to buy an option with three months of time premium left on it because you would be paying more for the extra time with the options purchase price. Nor would you buy an option with less that 30 days till expiration as time decay would erode the value of option so quickly that even if the options underlying stock movement moved favorably to you the time decay would prevent you from realizing a gain in the option itself.
The third thing to profitable stock option trading is understanding the relation of volatility between the market, the underlying stock that underlies the stock option, and the effect is has on the value of the option itself. When the general stock market as an index goes thru periods of volatility or low trading ranges the stocks that make up the market tend to follow overall trend and also begin to experience periods of low overall volatility which in turn can cause derivative like stock options to become cheap or low premiums. But if the markets volatility rises it is likely that individual stocks will follow the trend causing stock option premiums to increase in value given that the market moves in the traders favor. The next key in how to trade stock options successfully is having a stock option trading method that takes these key factors into consideration while giving clear entry signals, clear exit signals, a defined system of trade management, and a profit factor greater than your average loss over a series of trades. Knowing the ins and outs of various trade setups is useless if you dont have a trading methodology that guides you in every step of the trade process. A solid trading method holds you by the hand and defines each step while leading you to being a consistent winner in the markets and a profitable trader when all is said and done.
Finally, the fifth and final key to successfully trading stock options is yourself, particularly your trading psychology. Human beings and there mental makeup are extremely complex so it is extremely important that stock option traders not only have a sound stock option trading methodology but the discipline to follow their trading methods. You can give two people the same exact winning trading system but it is very common for them to have different results. Invariably, the one that has the ability to remain as detached from his losing trades as well as his winning trades while maintaining the discipline to follow the systems rules no matter the trading result will emerge the greatest winner in the end.
Using these five keys as a basis to develop your stock option trading methodology can help you avoid the mistakes and pitfalls of many beginning option traders. By understanding time decay, factoring an options time into your trading method, how volatility impacts a stock options value, what defines a reliable stock option trading methodology, and your own trading psychology you now have a foundation to develop into a winning stock option trader.
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