Getting Ready to Trade Options

Important facts you should know before placing your f irst options trade.

Getting Ready to Trade Options

How to avoid the 7 biggest mistakes new options traders make

Getting Ready to Trade Options

Welcome! By reading this booklet, youve taken the first

step toward becoming a successful options trader. We created this guide to provide you with the essential information you need to understand options trading. After all, trading options comes with its own set of unique guidelines similar to, but still very different from, trading stocks, bonds or commodities. Trading options requires a distinctive set of skills and a new way of thinking about the markets.

Inside
1. 2. 3. 4.

7 Common Mistakes

Before you get started trading options, be aware that there are some common mistakes that a new options trader might make. Here are 7 that are easy to avoid if you are aware of them from the start: 1. Assuming that it takes a professional trader to succeed with options Individual investors can trade options very successfully without having to have spent any time on the market floor. People around the world are learning options trading thanks to the availability of great education, online access to research, analysis, and brokers who are dedicated to the success of the individual investor. 2. Not having a pre-defined plan for each trade Sounds straightforward, but many new traders skip this step. Before entering a trade, be sure to have a plan for entry and exit of the trade.

Why trade options? What is an option? Is options trading risky? How do I develop a trading plan? 5. Do I need a broker to trade options? 6. Can anybody trade options? 7. How are commissions calculated in options trading? 8. How much money do I need to start trading? 9. Do I need a computer to trade options? 10. Do I need special software? 11. Can I practice before I make real trades? 12. Can I trade options full-time? 13. Can I trade options after market hours? 14. Can I really double or triple my money? 15. Do I need an investment advisor or financial planner? 16. How are taxes treated in options trading? 17. Where can I learn to trade options? 18. What should I look for in an investment education company?

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3. Trading options before learning how they differ from stocks and other trading instruments Options can cost less to trade than stocks do, which creates powerful reward potential. However they do have different rules than stocks do. Make sure to get educated and do some practice paper trading before trading in a real account. 4. Looking only at the potential reward and ignoring the potential risk. The reward to risk ratio is something that should be considered every time youre looking at an option trade. If youre risking $100 to potentially make $500, that may be a positive enough return that its an acceptable risk to you. Or, a trade may be risking $500 to potentially make $100. If that doesnt sound like a ratio that youre comfortable with, then move on and look for a new trade that better fits your goals. 5. Choosing a broker that doesnt specialize in options If youre going to trade in options, make sure you have a broker who specializes in options trading. Getting great fill prices and a competitive commission rate can make a big difference in your trading. 6. Putting all of your eggs in one basket Many stock traders miss this one as well. Just as with stock, its important to diversify when trading options. Avoid having all of your trades in one sector (such as technology, oil, etc.). By diversifying your portfolio, youre helping to control your overall risk as well. 7. Emotional investment in trades Its easy to get caught up in a trade and just know its going to go up forever, or if it starts going against you, that it will turn around and youll regain your original investment. Always have a plan for getting in and for getting out of a trade, and stick with your plan!

Getting Ready to Trade Options

1. Why trade options?

Options are one of the most versatile trading instruments ever, and can be extremely rewarding. They offer tremendous leverage, are surprisingly inexpensive, and when used properly, can reduce the overall risk of your trades. By simply learning to manage risk, you can actually create positions with a higher probability of profitability and accumulate healthier profits in less time than trading stocks. Options can be bought for less than 10 percent of a stocks value. Options can actually double in value when the stocks move as little as 5 percent. Options are available with expiration dates as far away as three years. Options enable you to make money no matter which way the market is headed.

These are just some of the many reasons why options trading is so attractive and continues to gain in popularity.

Why risk a lot to make a little when you can risk a little to make a lot?
Options have the capacity to dramatically increase your profits and limit your risk at the same time. By following fundamental risk management guidelines and trading strategies, you can enjoy significant success as an options trader. Best of all, unlike conventional buy-and-hold strategies, options offer you the opportunity to make higher returns on your investments in less time and with less cash upfront. People trade options for a variety of reasons, including: Hedging an existing equity portfolio Augmenting current income or savings Gaining increased market leverage without a large capital investment Whatever your personal financial goals are, infusing your long-term investments with options may be just the trick to increase your income or savings, protect against market downturns, and give you the leverage you need to be successful in the markets. Another great advantage of trading options is that you can actually make a profit in up, down, or sideways markets. Can your traditional mutual fund do that? In fact, trading options allows you to make money regardless of market direction. By buying put options, you can achieve leveraged gains with limited

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dollar risk when a stock price declines; and by purchasing call options, you can make leveraged gains on stock price increases. You can also use specific trading strategies that allow you to profit in flat markets as well.

2. What is an option?
Options are flexible investment instruments. Every option derives its value from an actual stock, which means that an options value is directly dependent on the price movement of its underlying security. Essentially, an option is a contract that gives you the right, but not the obligation, to buy (call) or sell (put) shares of the underlying stock. Each contract represents 100 shares of the underlying stock. Note: Buying a stock option contract does not obligate you to purchase or sell actual shares of the underlying stock. It only signifies that you have the right, or option, to buy or sell. Options have five main standardized terms by which they are defined: type of option (call or put); underlying asset; strike price; expiration date; and option premium. These terms distinguish each individual option from every other available option. Every time you enter a trade using options, these five terms define the parameters of your trade. To maximize your chances for success, it is essential to understand how these factors affect the nature of each trade. Options come in two flavors: calls and puts. Call options give you the right to buy the underlying asset at the option strike price. Put options give you the right to sell the underlying asset at the option strike price. The strike price is the fixed price at which the stock underlying an option can be purchased (call) or sold (put). Options are available in several strike prices at 2-point intervals, 5-point intervals, and 10-point intervals, depending on the price of the stock. The date an option expires is referred to as the expiration date. A stock option expires prior to close of business on the third Saturday of the expiration month. Therefore, as a retail trader, you must exit an options position by the close of business of the Friday before. In addition, all listed options have options available for the current month and the next month, as well as specific future months. Each stock has a corresponding cycle of months in which options are offered. Three fixed expiration cycles are available, each with a four-month interval:

Getting Ready to Trade Options

1. January, April, July, and October 2. February, May, August, and November 3. March, June, September, and December The price of an option is referred to as the option premium. It represents an options price, and is comparable to an insurance premium. If you are buying a put or a call option, you are paying the option holder a price for this privilege. This best explains why so often price and premium are used interchangeably. The specific cost of each option is derived from the following five factors: Price of the underlying stock in relation to the option strike price Time left until expiration Volatility of the underlying asset Current interest rates Dividends (if any) of the underlying stock

Four tips
for Managing Risk
1. Define your risk parameters.
Predefining your acceptable risk limitations ensures that you cannot lose more money than your maximum position loss.

3. Is options trading risky?

Trading is an art that requires practice, dexterity, and the ability to make quick decisions based on experience and observation. Mastering this art requires practice, grace, determination and flexibility. When used properly, options give traders the opportunity to achieve 5, 10, and even 20 times the gains achieved by stock or mutual fund investing, and with significantly reduced risk. Since options cost dramatically less than stocks, risk can often be limited to mere cents on the dollar when compared to buying stocks. However, trading and investing in securities always carries a degree of risk, and you may lose money. The bottom line? Only trade with risk capital money you can afford to lose. Every trade you place has a corresponding risk profile that graphically shows your potential risk and reward over a range of prices and time. As you learn and become more experienced, you will begin to understand underlying trends that you can use to limit and control your risk.

2. Be flexible.
A flexible trading plan enables you to optimally respond to market movements and to be entrepreneurial in seizing profitable opportunities.

3. Start by specializing.
When youre just starting out, specializing in just a few strategies allows you to refine your trading skills and develop tactics that consistently work in certain recognizable market conditions.

4. Grow gradually.
Good options traders start slow, collect new tools, resources and strategies, and systematically become better.

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One critical element in managing risk has nothing to do with options at all, and everything to do with you. Be honest with yourself and your finances. Determine how much money you can truly afford to risk and stick to it.

Four Common Myths About Options Trading

Myth #1:
Options are complex and difficult to understand.

4. How do I develop a trading plan?

Fact: The basic building blocks

of options calls and puts can be mastered quickly.

To be successful, you must evaluate the motivating factors behind your actions. What is your rationale for becoming an options trader? Would you like to supplement your income? Do you want to improve your family life? Do you have a desire to start your own business? Is retirement on the horizon? Would you like to travel more? Determining your trading objectives will help you develop your trading plan, which in turn will clarify what resources you can comfortably allocate to your trading. Your trading capital should not be your retirement assets, your emergency account(s), or money youve set aside for your children's education. When you are emotionally involved with your trading capital, you are often less likely to follow your own trading rules. A well-conceived trading plan requires you to identify the resources you have, the resources you can reasonably afford to risk, what you hope to earn, potential problems and suitable solutions. It obliges you to articulate where you are, where you want to go, and how you plan to get there. In essence, your trading plan is your road map. In the same way that you would not embark into unfamiliar territory without a map, you should not begin to trade without a clear plan of action. Remember, your plan can be as elaborate or as simplified as you like. Whatever your preference, plan your trade and trade your plan!

Myth #2:
Options are high risk.

Fact: Options trading

strategies were developed to control risk, and carry less risk than owning stocks outright. Used correctly, they can limit risk. Used incorrectly, they can result in losses beyond your original investment.

Myth #3:

Options are for professionals only.

Fact: Individual investors can

use options to diversify their investment strategies.

Myth #4:

I must sit at the computer all day.

Fact: Many popular strategies

are structured so that you can simply make your trade and walk away.

Getting Ready to Trade Options

5. Do I need a broker to trade options?

To trade options, you need to set up an equity options account with a brokerage institution. When evaluating brokers, try to select one with a trading philosophy that matches yours. For best results, set up your trading account with a company that specializes in options trading for both beginners and advanced traders. As an options trader, your main concern should be getting the transaction executed according to your wishes at the best possible price. A good, unbiased broker with indepth knowledge of options trading is your best bet to making that happen. Your brokerage is paid a commission when you place a trade, regardless of whether the trade makes any money. The commission fee varies depending on what kind of service your broker provides. When beginning the process of searching for a brokerage firm, its always a good idea to start with recommendations from friends, colleagues, and fellow traders. Evaluate potential brokers based on your particular needs and experience. For example, a seasoned options trader may be quite comfortable with a no-frills brokerage that offers low commissions and online trading; whereas someone new to options trading may prefer the hand-holding and personalized assistance that full-service brokerages provide.

A Special Offer for Optionetics Students

Introducing the optionsXpress Student Account

Designed just for Optionetics students, the optionsXpress Student Account gives you the opportunity to test your strategies using a Virtual Trade environment. And, when youre ready to venture into the real markets, youll start with 5 free trades, along with special, discounted trading rates offered exclusively for Optionetics students. No cost, no obligation and no initial cash balance required to open your account. It takes just 5 minutes to set up your Student Account. To qualify for this special offer, go to

www.optionsXpress.com/tradekit

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12 Questions to Ask a

Prospective Broker
1. What options-related tools and information do you offer? 2. Do you or your colleagues specialize in options trading? 3. Can your online service execute complex options orders such as spreads, straddles, and combination strategies in one trade online? 4. What is your minimum account size for options trading, and what margin requirements do you demand? 5. How fast are orders executed? 6. What is your commission fee schedule? Are there hidden fees that I should be aware of? 7. Do you offer trading via telephone and online trading via Internet/computer? 8. Can I trade after hours? 9. Do you offer streaming realtime quotes? 10. Do you provide stock charts, earnings estimates, research reports, screening, alerts, quotes, and news on your Web site? 11. Do you offer a trading demo? Some sites allow you to develop hypothetical trades and view the results. 12. Is your online broker site easy to navigate and intuitive to use? Does it allow easy access to the trading portion of the Web site?

6. Can anybody
trade options?

Yes. In addition to completing your

standard brokerage account application, youll be required to complete a separate options agreement. The purpose of this form is to gather information regarding your investment experience and knowledge of different types of options trading strategies, as well as the number of options trades you have initiated in the past. (Based on your level of experience and financial profile, your broker may impose limits on your trading; for example, the use of credit, limit-specific options strategies, or the purchase of certain speculative investments.) You will also be given a booklet entitled, Characteristics and Risks of Standardized Options. This guide, which is published by the Options Clearing Corporation (OCC), is provided to all prospective options account holders, and provides a general explanation of equity and index options, as well as the risks incurred with various types of positions.

7. How are commissions calculated in

options trading?
When you trade options, you pay a commission on both the entry and the exit of options positions. The commission is added to the total cost or deducted from the proceeds of the trade. If an option expires worthless, only entry commissions are paid. Remember that commissions vary widely between brokerage firms and can be adjusted by factors such as account size and activity,

Getting Ready to Trade Options

along with trading method. For example, spreads, straddles, and other trades are generally charged two commissions, one for each side of the trade. The good news, however, is that with the expanding popularity of options trading, many deep discount firms and others that offer highly specialized options trading expertise are lowering their commission levels.

8. How much money do I need

to start trading?

Contrary to what you may be thinking, you dont need a lot of money to trade options. In fact, some traders begin with very little in their trading accounts. Its a good idea to start out using less money so that you risk losing less. That way, you can build up your knowledge base, refine your skills, and become better prepared to trade with larger sums. Your trading plan should provide you with insight into how much you can comfortably start with. In addition, some but not all brokers may have predetermined minimal investment amounts with which you must comply. Above all, we recommend starting out conservatively, and investing wisely with money that you can afford to lose. When you become more skilled and confident in your trading, you can add more money.

9. Do I need a computer
to trade options?
Modern technology has made options trading easier and quicker than ever, but you can still place trades using a telephone. However, most options traders prefer the convenience and speed of a computer. With your home computer and an Internet connection, you can be up and running in no time. Always make sure that your computer is secure and keep your passwords protected.

10. Do I need special software?

While trading options does not necessarily require you to purchase software, a comprehensive options analysis software tool will allow you to quickly select among millions of possible trades. You may want to subscribe to a hosted (online) software application to reduce your upfront costs. Of course, you can still trade options by scanning your daily newspaper and calling in your trades, but by using software, you can find single option or combination trades that meet your predefined criteria in just a matter of seconds.

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Comprehensive risk graph analysis For all of your personal trades. Implied volatility rankings Tailored to every option you choose. Trade selection matrix For matching trades with your market preferences. Paper trading So you can practice before committing real dollars. Historical backtesting capabilities For options going back at least 2 years. In-depth portfolio management Including daily emails of profit/loss performance. Scanning and search capabilities To help you find the trades that meet your criteria.

Make sure that the software you choose provides:

11. Can I practice before I make real trades?

The ideal way to test your trading skills without putting any of your money on the line is by paper trading. Paper trading allows you to make simulated trades. Good options analysis software will include the capability for paper trading. Hypothetical trades are great for developing practical experience, and for testing your ideas and your ability to implement them properly prior to using real dollars. Whenever you learn a new strategy, take the time to paper trade, practice, and test it repeatedly so that when you are ready to apply your money, you feel confident in your abilities to execute the trade as best you can.

12. Can I trade options full-time?

Many people trade options as a full-time job. However, it is a good idea for people just starting out to trade part-time until you acquire the skills, knowledge and confidence to be successful full-time. The right time to consider making options trading your full-time job is once you are consistently trading profitably and understand the strategies.

13. Can I trade options af ter market hours?

One of the benefits of trading options is that you can check your positions in your spare time, in the evenings, or on weekends when the markets are closed. In fact, you do not need to have access to the markets during the day to trade. Whats more, many professional options traders recommend not trading during market hours in order to avoid making impulsive moves.

Getting Ready to Trade Options

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14. Can I really double or triple my money?

Options trading, just like any other investment, does not come with any guarantees. However, since trading options provides increased leverage of your capital, you may make money faster than with stocks. In addition, you may better hedge your trades by employing different strategies that are geared to varying timeframes. For instance, you can choose among short-term (30-60 days), longer term (60120 days) and other specialized trades that can extend up to two years. Your returns will depend on how much time and effort you are willing to invest in your trading and what strategies you decide to use. In addition, market fluctuations beyond your control, resulting from corporate mergers/acquisitions and other unforeseen world events, can impact your trading outcomes. Remember that becoming a skilled options trader takes time, patience and practice. Trading is an art and a science, and requires a commitment in order to achieve success.

15. Do I need an investment advisor or financial planner?

You may already have a good investment advisor or financial planner to guide you in other aspects of your financial life. As you become increasingly skilled at options trading and build your assets, you may want to consider attending wealth-preservation seminars to gain knowledge about how to optimally manage and protect your money.

16. How are taxes

treated in options trading?

We recommend that you consult your tax specialist for specific questions relating to options trading and taxes. It is important to understand that every executed options trade (initial purchase or sale, followed by a closing sale, purchase, expiration, or assignment) will result in a realized capital gain or loss of some quantity, which must be reported to the IRS.

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Keep accurate records of all of your trading activity. Maintain a paper trail of all of your trades, including confirmations of quantities, purchase and sales price data, associated costs and proceeds.

11 Questions to Ask Before Choosing an

Options Trading Seminar

17. Where can I learn to trade options?

Once you have developed your trading plan and assembled your technology infrastructure, the next step is to get educated. When it comes to options traders, the most successful and fulfilled ones consistently read, gather information, attend and re-attend trading courses, and stay current on market trends. It is also a good idea to become actively involved in your local trading community. Make the effort to align yourself with an investment education organization that provides a variety of continued learning opportunities, new technology and innovative strategies to fit the ever-changing market. Building and maintaining a long-term relationship will allow you to take advantage of special discounts on educational materials and tuition, options trading software, and many other products and opportunities that can significantly pay off over time. One of the best ways to quickly get up to speed is by attending a live seminar. These interactive venues provide an energetic environment for active learning, and can be a great way to invigorate your trading. As you evaluate potential seminars, keep in mind that they are not created equally, so be sure to do your homework before committing your time and money to one.

1. Is the seminar taught by professional traders? 2. Does it provide a 100% money-back guarantee? 3. Are attendees eligible to receive special offers, product discounts, and free technical/trading support? 4. What is included in the price of the seminar? 5. Are comprehensive home study materials available? 6. Does the seminar offer you the chance to re-attend at no charge? 7. Is the range of strategies and resources presented comprehensive? 8. Can you bring a guest along at a reduced rate? 9. Does the seminar have a long history of satisfied students? 10. Is it geared toward beginning traders? 11. Are advanced educational opportunities available?

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18. What should I look for in an investment education company?

When evaluating organizations that specialize in options trading education, make sure that you choose one that offers a broad range of educational materials and capabilities. Look for a firm that has been around for a long time, through market ups and downs, and with a strong following of satisfied students. Make sure it caters to people seeking basic options trading education and advanced trading strategies. The company you choose should provide the following benefits:

trading classes and workshops Live educational events are one Live
of the best ways to learn about minimizing risk, maximizing profits, and discovering everything options trading has to offer.

publications Whether delivered to you online or via standard Trading

postal delivery, informative trading newsletters offer invaluable opportunities to stay current on market trends. Many are niche-oriented toward specific premium strategies, and some are free. DVDs allow you to practice and refine your trading skills from the comfort of your own home. help you identify the trades that best satisfy your predefined criteria.

study materials Workbooks, study guides, videos, books, CDs and Home software Software applications (with paper trading capabilities) Trading

Discounts and special offers Monthly or quarterly promotions make it easy

and affordable for you to keep current on the latest trading strategies. community is a great way to exchange ideas, discuss trading tactics, and gain new perspectives. stocks on the move, and profitable trading strategies can help you significantly increase your winnings.

Discussion boards Interaction with a local or global options trading

commentary Access to the latest data about market conditions, Market Educational articles Get inside the heads of professional traders and

learn what they recommend, what they avoid, and what you can do to grow your earnings. idea to educate yourself about the best ways to manage and protect your money, and explore tax-saving strategies that can really pay off.

Preservation Education Once you increase your profits, its a good Wealth

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About Optionetics
Since 1993, Optionetics has provided investment education services and trading tools to more than 336,000 people from over 50 countries. Every day, our popular high-reward strategies help traders successfully navigate the markets and chart paths to financial security. In fact, we not only stand by our pledge to provide the highest quality investment education possible, we guarantee it. Optionetics high-profit, low-risk, low-stress trading strategies are based on over two dozen techniques perfected by master trader George Fontanills, founder of Optionetics. Avoiding overly theoretical or technically complicated material, Optionetics represents a practical, balanced approach to trading profitably in todays markets. Our diverse range of educational offerings includes:

classes workshops home study materials sof tware

publications CDs and DVDs books

Choose Optionetics for the premier educational resources and tools to help you become the successful trader youve always wanted to be.

Getting Ready to Trade Options

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About George Fontanills

An active trader, George founded Optionetics to help people understand the world of stock and options trading. Specializing in delta neutral trading using stocks, options on indices, and options on stocks, he has instructed thousands of traders internationally. His trading breakthroughs have led to numerous guest appearances on radio and television shows all over the country and have been the subject of articles in the Wall Street Journal, Barrons, Research Magazine, CBS MarketWatch, and TheStreet.com. A published author, his works include The Options Course, Trade Options Online, The Stock Market Course and The Volatility Course. George Fontanills

Contact Us

Headquarters: 255 Shoreline Drive, Suite 100 Redwood City, CA 94065 Web site: www.optionetics.com

Telephone: (888) 366-8264 (650) 802-0700 Fax: (650) 802-0900

Optionetics products and services are analytical tools offered for educational and informational purposes only and are not intended to replace individual research or licensed investment advice. The purchase, sale or advice regarding a security can only be performed by a licensed Broker/Dealer and/or Registered Investment Advisor. Optionetics is not registered as a Broker-Dealer, Investment Adviser, in any state or otherwise Optionetics does not make investment recommendations or provide financial, tax or legal advice. Anyone using Optionetics products and services is encouraged to consult a licensed representative of their choice regarding any particular investment or investment strategy. No representation is being made that Optionetics products and services will guarantee profits and prevent trading losses. Trading stocks, currencies, futures, commodities or options thereto involves substantial risk and there is always the potential for loss. Because trading results may vary, dont trade with money that you cant afford to lose. Testimonials are non-representative of all Optionetics students. Certain students trading accounts may have performed worse than the accounts of the students providing the testimonials. Commodity and futures options are typically high-risk endeavors. Persons considering trading commodity futures or options should educate themselves about futures and options and realize that they may lose large sums of money. You should factor into your purchase decision the impact of commissions and fees that can result from frequent trading and the additional cost of any data feed that may be required. Company names, products, services and branding cited herein may be trademarks or registered trademarks of their respective owners and the owners retain all legal rights. 2010 Optionetics, Inc. All rights reserved. Optionetics, Inc. and optionsXpress, Inc. are affiliated companies under common ownership of optionsXpress Holdings, Inc. Optionetics and its affiliates, officers, employees, independent contractors, and former owners may receive compensation in connection with marketing efforts, may not be registered as a Broker-Dealer, Investment Adviser, with any state, or otherwise, and their materials, products and services may not be reviewed and/or approved. Further information is available at http://www.optionetics.com/about/legal.asp. Optionetics.com is an educational portal of optionsXpress Holdings, Inc., providing content for educational and informational purposes only. optionsXpress Holdings, Inc. is not a broker/dealer. Investors need a broker to trade options, and must meet certain requirements. All securities, futures, and investments are offered to self-directed investors by optionsXpress, Inc. Member FINRA, SIPC, CBOE, ISE, ArcaEx, PHLX and NFA, or its affiliated . All prices in USD unless noted otherwise.