How to buy stock options trading stock options

It seems like a good place to start: buy a call option and see if you can pick a winner. Many veteran equities traders began and learned to profit in the same way. Buying calls may also feel safe because it maps to the pattern you’re used to following as an equity trader: buy low, sell high, in that order.
And yet, buying calls outright is one of the hardest ways to consistently make money in the options world. If you limit yourself to this strategy, you may find yourself losing consistently and not learning very much in the process. Consider a few other strategies as well in jump-starting your options education – and improve your potential to earn solid returns as you build your knowledge.

It’s tough enough to call the direction on a stock purchase. But when you buy options, not only do you have to be right about the direction of the move, but you also have to be right about the timing.
Each day that passes when the option doesn’t move is like an ice cube sitting in the sun. Just like the puddle that’s growing, your time premium is evaporating in the options price until expiration.

This is especially true if your first purchase is a near-term, way out-of-the-money option, a popular choice with new options traders because they’re usually quite cheap. Not surprisingly, though, these options are cheap for a reason: they aren’t statistically likely to make big moves.
Options also have a higher cost of doing business. The bid/ask spread is usually much wider on the options than the stock; while option spreads only go as low as $0.05 between the bid and ask, stocks often trade in penny increments. Think of it this way: if you’re trading an option quoted at $2.00, and the bid/ask spread is $0.05, that’s actually 2.5% of your trade. As soon as you’ve opened the position, you’re instantly down 2.5%, just from the spread.

Option trading is remarkably flexible – options literally can give you more options, or choice, in trading effectively in all kinds of market conditions. But you can only take advantage of this flexibility if you stay open to learning about new strategies.
Spreads offer a great way to respond to different market conditions. All new options traders should familiarize themselves with the possibilities of spreads, so you can begin to recognize the right conditions to use them.
A spread is a position made up of two of the same options – same underlying, same expiration date, same number of contracts, same type, either both puts or both calls - differing only in their strike price.
With a spread trade, since you bought one option at the same time you sold another, time decay that could be hurting one leg is actually helping the other. Your chances of beating time decay as a spread trader are usually better versus just outright buying options.

The downside to spreads is that your upside potential is limited - but frankly I don’t know too many call buyers that actually make sky’s-the-limit profits on their trades. Most of the time, if the stock hits a certain price, they sell the option anyway. So why not set the sell target when you enter the trade?
There are two caveats to keep in mind with spread trading. First, because these strategies involve multiple options trades, they incur multiple commissions. Make sure your profit-taking calculations include commissions as well as other factors. Second, as with any new strategy you’re trying, know your risks before committing capital.

Because spread trading involves a short option, if that option or its underlying rise sharply in value, the option buyer may exercise, requiring you to deliver either the underlying or its equivalent in cash.
Remember: options are a decaying asset – and that rate of decay only accelerates as your expiration date approaches. If the move you were expecting doesn’t happen within the period expected – get out and move on to the next trade. I have seen many beginning traders not get out soon enough on profitable trades and stay way too long in losers.
(Time decay doesn’t have to hurt you, of course. Selling options without owning them lets you put time decay to work for you. In other words, you’re successful if time decay erodes the buyer’s price, allowing you to keep the sale premium. The flipside, of course, is that a seller opens himself up to unlimited risk if the buyer turns out to be right – and if the seller hasn’t managed his risk in advance with a solid hedge or exit strategy.)