Getting Ready to Trade Options 1

Getting Ready
to Trade Options
Important facts you should know before placing
your f irst options trade.

How to
avoid the
7 biggest
mistakes
new options
traders
make
 Getting Ready to Trade Options 1
Welcome! By reading this booklet, you’ve 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. Why trade options?
7 Common Mistakes 2. What is an option?
Before you get started trading 3. Is options trading risky?
options, be aware that there are some 4. How do I develop a trading
common mistakes that a new options plan?
trader might make. Here are 7 that are 5. Do I need a broker to trade
easy to avoid if you are aware of them options?
from the start: 6. Can anybody trade options?
7. How are commissions
calculated in options
1. Assuming that it takes a trading?
professional trader to succeed 8. How much money do I need
with options to start trading?
• Individual investors can trade 9. Do I need a computer to
trade options?
options very successfully without
10. Do I need special software?
having to have spent any time on
11. Can I practice before I make
the market floor. People around real trades?
the world are learning options 12. Can I trade options full-time?
trading thanks to the availability 13. Can I trade options after
of great education, online access market hours?
to research, analysis, and brokers 14. Can I really double or triple
who are dedicated to the success my money?
of the individual investor. 15. Do I need an investment
advisor or financial planner?
2. Not having a pre-defined plan for 16. How are taxes treated in
options trading?
each trade
17. Where can I learn to trade
• Sounds straightforward, but many options?
new traders skip this step. Before 18. What should I look for in
entering a trade, be sure to have a an investment education
plan for entry and exit of the trade. company?
2

Q
Optionetics

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 you’re looking at an option trade. If
you’re risking $100 to potentially make $500, that may be a
positive enough return that it’s an acceptable risk to you. Or,
a trade may be risking $500 to potentially make $100. If that
doesn’t sound like a ratio that you’re comfortable with, then
move on and look for a new trade that better fits your goals.

5. Choosing a broker that doesn’t specialize in options

• If you’re 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,
it’s important to diversify when trading options. Avoid having
all of your trades in one sector (such as technology, oil, etc.).
By diversifying your portfolio, you’re helping to control your
overall risk as well.

7. Emotional investment in trades

• It’s easy to get caught up in a trade and just “know” it’s
going to go up forever, or if it starts going against you, that
it will turn around and you’ll regain your original investment.
Always have a plan for getting in and for getting out of a
trade, and stick with your plan!
 3

Q
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 stock’s 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
4 Optionetics

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 option’s 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
2½-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 option’s 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 5
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
option’s 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

Four tips
the following five factors:
• Price of the underlying stock in relation to
the option strike price
• Time left until expiration for Managing Risk
• Volatility of the underlying asset
• Current interest rates
• Dividends (if any) of the underlying stock 1. Define your risk
parameters.
3. Is options Predefining your acceptable
risk limitations ensures that you
trading risky? cannot lose more money than
your maximum position loss.
Trading is an art that requires practice, dexterity,
and the ability to make quick decisions based 2. Be flexible.
on experience and observation. Mastering this A flexible trading plan enables
art requires practice, grace, determination and you to optimally respond to
flexibility. market movements and to
be entrepreneurial in seizing
When used properly, options give traders the profitable opportunities.
opportunity to achieve 5, 10, and even 20 times
the gains achieved by stock or mutual fund 3. Start by specializing.
investing, and with significantly reduced risk.
Since options cost dramatically less than stocks, When you’re just starting
risk can often be limited to mere cents on the out, specializing in just a few
dollar when compared to buying stocks. However, strategies allows you to refine
trading and investing in securities always carries your trading skills and develop
a degree of risk, and you may lose money. The tactics that consistently work
bottom line? Only trade with “risk capital” – in certain recognizable market
money you can afford to lose. conditions.

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.
4. Grow gradually.
Good options traders start slow,
collect new tools, resources and
strategies, and systematically
become better.
6 Optionetics
Four Common
Myths About
Options Trading
Myth #1:
Options are complex and
difficult to understand.
Fact: The basic building blocks
of options – calls and puts – can
be mastered quickly.
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.
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.
4. How do I develop a
trading plan?
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 you’ve 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!
 Getting Ready to Trade Options 7
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 in-
depth 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, it’s 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 you’re ready to venture
into the real markets, you’ll 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
8 Optionetics
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 real-
time quotes?
10. Do you provide stock charts,
earnings estimates, research
reports, screening, alerts,
quotes, and news on your When you trade options, you pay a commission
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, you’ll
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?
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 9
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 don’t need a lot of money to trade
options. In fact, some traders begin with very little in their trading accounts. It’s
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.
10 Optionetics

Make sure that the software you choose provides:

• 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 ½ 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.

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.
What’s more, many professional options traders recommend not trading during
market hours in order to avoid making impulsive moves.
 Getting Ready to Trade Options 11
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 (60-
120 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.
12 Optionetics
11 Questions to Ask
Before Choosing an
Options
Trading
Seminar
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 advantage of special discounts on educational
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?
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.
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
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.
 Getting Ready to Trade Options 13
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:


Live trading classes and workshops – Live educational events are one
of the best ways to learn about minimizing risk, maximizing profits, and
discovering everything options trading has to offer.

Trading publications – Whether delivered to you online or via standard
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.

Home study materials – Workbooks, study guides, videos, books, CDs and
DVDs allow you to practice and refine your trading skills from the comfort of
your own home.

Trading software – Software applications (with paper trading capabilities)
help you identify the trades that best satisfy your predefined criteria.

Discounts and special offers – Monthly or quarterly promotions make it easy
– and affordable – for you to keep current on the latest trading strategies.

Discussion boards – Interaction with a local or global options trading
community is a great way to exchange ideas, discuss trading tactics, and
gain new perspectives.

Market commentary – Access to the latest data about market conditions,
stocks on the move, and profitable trading strategies can help you
significantly increase your winnings.

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.

Wealth Preservation Education – Once you increase your profits, it’s a good
idea to educate yourself about the best ways to manage and protect your
money, and explore tax-saving strategies that can really pay off.
14 Optionetics

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
today’s markets. Our diverse range of educational offerings includes:

• classes • publications
• workshops • CDs and DVDs
• home study materials • books
• sof tware

Choose Optionetics for the premier educational resources and tools to help you
become the successful trader you’ve always wanted to be.
 Getting Ready to Trade Options 15
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, Barron’s, 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: Telephone:
255 Shoreline Drive, Suite 100 (888) 366-8264
Redwood City, CA 94065 (650) 802-0700

Web site: www.optionetics.com 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, don’t trade with money that you can’t afford to lose. Testimonials are
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accounts of the students providing the testimonials.
Commodity and futures options are typically high-risk endeavors. Persons considering trading commodity futures or
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Company names, products, services and branding cited herein may be trademarks or registered trademarks of their
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© 2010 Optionetics, Inc. All rights reserved.
Optionetics, Inc. and optionsXpress, Inc. are affiliated companies under common ownership of optionsXpress Holdings,
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