Thread by @asitbaran

1. Received quite a few messages asking abt Options Guidelines. This is to all those who don’t know the beast nd its characteristics that well. Trading options can be risky business at best and disastrous at worst. Here, are few points how to handle it. Took a while to put it..

2. Bit lengthy but am sure it'll add value. A guideline for people to understand the nuances of the instrument.

Way back in 2013, I traded Options for the first time, without even knowing anything about Greeks and almost lost around 70% of capital in no time trusting Friends

3. from Indore. Little did I know back then, Options will be my bread and butter down the line. So here it goes.

A. Learn Option Theory and strategies and the Greek risks (Don't believe the experts who say Greeks don't matter)

Acquire an option theory education

4. especially about the GREEKS, and become well-versed in core option dynamics. Without this knowledge you shouldn’t be actively involved in the option markets. Options are great tools but they are not a “straight up” proposition like stocks (Cash / Futures)

5. There are complexities and risks to options that are not readily apparent. Not fully understanding how options work and how to assess the risk that an option position may put a trader at a disadvantage. Put simply, the GREEKS identify and quantify the risks of the individual

6. option or position for you prior to your putting on the trade

B. Be patient in the learning process and then trade small until you develop a comfort level.

Once you have experienced, and are comfortable with, the way the option or option strategy trades and reacts to

7. movements of stock, time, and volatility, you can go to trading real money. As you start to trade real money, stay with very small amounts at first. Things change drastically when real money is on the table. That cool confidence goes to hell when market goes against you.

8. Learning at a smart, patient pace and then trading small to start can save a novice trader a lot of money

C. Acquire a basic knowledge of charting

Modest technical analysis tools can greatly enhance returns over time. Having an idea of the potential future movement of the

9. stock will make it easier to pick and construct the optimal strategy for the identified opportunity. Further, knowing even just a few key concepts of TA can assist traders in avoiding dangerous situations that are better left alone

10. Always know the risks of the trade and any possible news events that could affect your stock and option price that is, earnings, dividends, announcements

D. Always evaluate where you are in the implied volatility range.

While there are many components that affect option

11. prices, it’s a rarity when any are more important than volatility. Extrinsic value is the essence of an option, and volatility is the biggest component of extrinsic value. It’s an absolute must to know where the current implied volatility of an option is in relation to its

12. preceding range, Historical Volatility (volatility stochastic).

Not understanding this has left many new option traders baffled when they’ve gotten their anticipated move from an underlying, only to lose money on the trade. Not knowing what volatility is and how it works is

13. unacceptable. It’s critical to have volatility working for you and not in opposition. A rudimentary understanding of the math involved or definition of volatility is not enough. Unfortunately, most new traders tend to learn this fairly late into the game

14. Not understanding the independent effects of time and volatility on your option. Have you ever bought a call when you thought a stock was going to rise, only to have it lose value when it did not? we can blame it on time and volatility. Unlike stocks, an option’s price

15. relies on more than one variable. They are sensitive to the passage of time (theta) and changes in implied volatility (Vega). These variables are independent of each other, the stock price movement, and the option’s sensitivity to it (delta). The selected option’s delta gave

16. us money as the stock went up. Unfortunately, it was sensitive to time and volatility. These variables depleted more value out of the option contract than the delta put into it, creating a loss even with a rising stock Without understanding time and volatility,

17. you would not know what happened in this scenario and would probably be discouraged from trading options.
(Don't worry, you are not alone there are many including some experts from selling domain who don't get it 😎😎)
By learning more about time and volatility, you can be

18. better prepared to select the proper option

Pro tip: Buy an ITM option with a delta around 80–85 the next time you want to put an option in place of a stock for a stock directional play. This option will mimic the stock closely.

19. ITM options are much less sensitive to the adverse effects of time and volatility

E. Understanding the cheapness or expensiveness of Option is determined by cost of Option

One of the biggest mistake traders make when looking at options is that they think that whether an

20. option is cheap or expensive is determined by amount invested. What they fail to see is that the strike price, among other things, predicates cost of the option. Options with different strike prices have different values. These different option strikes have different deltas

21. associated with them. One of the definitions of Delta is that of a POP. Since all of these options have an associated percentage chance of being ITM at expiration, they will have different values. This means that options that are already ITM have a better chance of finishing

22. ITM and are more expensive. OTMs options are less likely to finish ITM by expiration, so they are less expensive.

Point am making is that invested capital doesn’t dictate expensiveness or cheapness; strike price along with POP does. And it’s all relative.

23. The question is how to relate the cost difference between options of different strikes to determine cheapness or expensiveness. This is done through IV, which is the only way to determine whether an option is expensive.

24. Although options are separated by different months (weeks for index) and strike prices, they are similar under IV. A higher level of IV means a more expensive option and vice versa. IV is the unifying factor between the prices of all options. Using it, we can determine

25. whether any option is truly cheap or expensive

Education on volatility, and IV in particular, is critical. This offers a better understanding of an option’s true value. The study of volatility sheds new light on whether an option is cheap or expensive.

26. Education on volatility, and implied volatility in particular, is critical. This offers a better understanding of an option’s true value. The study of volatility sheds new light on whether an option is cheap or expensive. It also reveals the importance of its extrinsic value

27. the essence of an option, which is largely a function of time and volatility

F. Do a volume/liquidity analysis. Always try to initiate positions in products with liquidity

Options with low volume or poor liquidity are more difficult to extract profits from or to neutralize

28. risk. The bid–ask spread can be much more cost-prohibitive than in the equity itself if it’s a low-option volume equity. Restricting screening criteria to a certain level of option volume, market size, or bid/ask spread will keep traders from getting involved in thin issues.

29. Be aware that open interest is not a truly telling form of measuring liquidity. True liquidity is determined by the size and spread of the market, not open interest..

30. Last but not the least, Knowledge is Power. Spend time in acquiring knowledge. These are the books that helped me immensely, read them and spend time taking notes (old school, but it helps)

31.

1. Options, Future & Other Derivatives - Hull
2. Option Volatility and Pricing - Sheldon Natenberg
3. Trading Option Greeks: How Time, Volatility, and Other Pricing Factors Drive Profit - Dan Passarelli
4. The Bible of Options Strategies - Guy Cohen

32.

5. The Options Playbook - Brian Overby
6. Options as a Strategic Investment - Lawrence G. McMillan

Hope the post helps you just to kickstart the journey about Options Trading. Just put hard work and you can tame the beast..Cheers

To add to the above list, couple of personal favs by Taleb, Fooled By Randomness & Dynamic Hedging (still reading).

The statistic that 90% of all option positions lost money is meaningless (i.e., the frequency) if we do not take into account how much money is made

on average the remaining 10%, Do read Fooled By Randomness, to gain the proper understanding of the probability of hitting a strike price at expiration. Just thought adding these splendid books as well...