Guide to Options Trading

OPTIONS - EVERYTHING YOU NEED TO KNOW

Chloe Trades - Complete Beginner Guide to Options Trading

1 Disclaimer

This book is designed for educational purposes only and should not be considered as financial advice or a substitute for professional guidance. Options Trading carries inherent risks and may not be suitable for all individuals. The author assumes no responsibility for any financial losses or consequences resulting from the use of the information provided. Readers should conduct their own research and seek personalized advice before making any investment decisions, recognizing the potential risks and rewards involved. By reading this book, readers accept the terms of this disclaimer, understanding that it does not replace personalized financial advice.

Copyright © 2023 by Chloe Trades. All rights reserved. No part of this book may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law. Illustrations by Chloe Trades. 1st Edition 2023 www.chloectrades.com

2 CONTENTS

• Preface
• I. INTRODUCTION TO OPTIONS TRADING
  • Trading Terminologies
  • Stock Market Hours
  • Types of Analysis
  • Market Participants
• II. UNDERSTANDING THE CHART
  • Candlesticks
  • Chart Patterns
  • Support & Resistance
  • Trendlines
  • Gaps
  • Market Structure
  • Trading Styles
  • Trends vs. Consolidation
  • Indicators
• III. OPTIONS PRICING
  • The Greeks
  • Risk Management
  • Trading Plan
  • Types of Orders
  • Types of Strike Prices
  • Cost of Trading
• IV. PUTTING IT TOGETHER
  • Trading Psychology
  • Price Action
• V. STARTING YOUR TRADING JOURNEY
  • Getting Started
  • Paper Trading vs. Live Trading
  • Trading Routine
  • Stock Selection
  • Buying & Selling Contracts
  • Backtesting & Journaling
  • Quitting a 9-5 Job

3 Preface

Whether you're a complete beginner or someone who has dabbled in the markets before, let this be your comprehensive guide to Options Trading. I wrote this book to shorten your learning curve by providing all the basics of Options Trading in one place. When I first started, I was overwhelmed by the sheer amount of information and spent hours trying to understand what I needed to know. My aim is that this book will serve as your comprehensive guide as you embark on your trading journey.

A little bit about me – my real name is Chloe Chow and I go by Chloe Trades. Before I became an Options Trader, I was working as a Process Engineer. Society often teaches us that a 9-5 job is the traditional path to financial stability and success. After working in the corporate world, I soon realized it didn't bring me the happiness and satisfaction I had hoped for. I wanted the freedom to control my own time, finances, location and essentially escape the rat race.

I was introduced to Options Trading and was captivated by the freedom it could provide. I started spending every waking hour learning and practicing with the goal of quitting my job. Two years later, I was able to do so. Failures in trading can be very discouraging – trust me, I’ve been there. The rule is not to give up – “Winners never quit, and quitters never win.” Every failure you have is a price you pay to become a successful trader, so make sure you are learning from each and every one of your mistakes.

I hope you enjoy this book and find it useful as you embark on your Options Trading journey!

I. INTRODUCTION TO OPTIONS TRADING

What is Options Trading?

Options Trading is a type of investing where traders buy and sell options contracts. It's a way for them to make predictions about the future price of assets – they profit from these predictions if they are correct. Whether the stock market goes up or goes down, traders have the opportunity to make money.

Difference between Investing in Stocks & Trading Options

• Investing in Stocks: Grants you partial ownership of the company. It involves a long-term approach to participate in a company's growth and profitability. Stock investors make money when the value of the stock increases.
• Trading Options: Allows you to bet on the direction you think a stock price is headed. It is a short-term strategy focused on speculating price movements. Options Traders can make money when the value of the stock increases or decreases.

Example: TSLA Chart – October 27, 2023.

Trading Terminologies

1. Bull

A bull is a buyer who is optimistic and expects prices to go up, aiming to make a profit by purchasing assets and selling them at higher prices. A bull is referred to as ‘bullish’ when describing their optimistic outlook.

2. Bear

A bear is a seller who is pessimistic and expects prices to go down, aiming to make a profit by selling assets and buying them back at lower prices. A bear is referred to as “bearish” when describing their pessimistic outlook.

3. Bull Market

A bull market is when prices in the market are going up, indicating a positive and optimistic trend.

4. Bear Market

A bear market is when prices in the market are going down, indicating a negative and pessimistic trend.

5. Call Option (Calls)

When a trader predicts that price will go up, they buy a call option – if the price goes up, they make money.

6. Put Option (Puts)

When a trader predicts that price will go down, they buy a put option – if price goes down, they make money.

7. Position

Indicates whether a trader is currently holding a call or put option.

8. Ticker

A unique series of letters representing a stock, it's used for quick identification. E.g., Tesla’s Ticker is TSLA.

9. Bid

The highest price at which a buyer is willing to purchase the asset.

10. Ask

The lowest price at which a seller is willing to sell the asset.

11. Spread

Difference between the bid price and ask price.

12. Premium

The cost of buying an options contract.

13. Strike Price

It represents the price at which the stock can be bought or sold if the options contract is exercised. This is the price you expect the stock to move towards or surpass.

14. Slippage

Difference between the expected price of a trade and the actual price at which the trade is executed. Slippage can result in a trade being filled at a less favorable price than initially anticipated.

15. Expiration Date

The expiration date is the deadline by which the option contract becomes invalid. It's like the "use by" date on a coupon; after which, it becomes worthless. If the trader holds their position until their contract(s) expires, they lose the money they paid to buy it. The key is to exit when the profitability target is reached or when losses have been incurred to the extent that is no longer manageable or tolerable.

16. Intrinsic Value

Difference between the current stock price and the strike price.

17. Time Value

Time value is the additional value an option has beyond its intrinsic value. It represents the potential for the option to gain value before expiration – it decreases as the option approaches its expiration date.

18. Long Position or ''Going Long''

A long position refers to buying a call option with the expectation of the stock price rising.

19. Short Position or ''Going Short''

A short position involves buying a put option with the expectation of the stock price declining.

20. Trend

The direction a stock is heading.

20.1 Uptrend

The overall direction of the stock is upward.

20.2 Downtrend

The overall direction of the stock is downward.

21. Consolidation

A period of relative stability indicating a pause in the market.

22. Trendline

A straight line drawn that connects consecutive lows or consecutive highs and helps to visualize and identify the direction of a market trend.

23. Support

A price level below current price. When price comes to this level, it stops and may reverse its direction to the upside.

24. Resistance

A price level above current price. When price comes to this level, it stops and may reverse its direction to the downside.

25. Breakout

A significant price movement where price ‘breaks’ above a resistance level or ‘breaks’ below a support level.

26. Rejection/Bounce

The opposite of a breakout – price fails to break support/resistance and instead reverses direction.

27. Fakeout

A false breakout where price moves outside a chart pattern or significant area, only to move back inside.

28. Confluence

The occurrence of multiple factors aligning at the same price level or time, increasing the likelihood of a significant price movement in a certain direction.

29. Volume

The total number of shares traded during a specific period, showing how active the market is.

30. Volatility

The rate at which the price of a stock increases or decreases, showing how unpredictable or stable it is.

31. Liquidity

The ease and speed at which you can enter or exit a trade.

32. Rally

Refers to a significant and sustained upward movement in the price of an asset, typically accompanied by increased buying activity and positive market sentiment.

33. Fill

The execution of a trade order.

34. Entry

The price at which a trader enters a trade.

35. Exit

The price at which a trader exits a trade.

36. Profit Target

The price at which a trader aims to exit their position and take their profits.

37. Stop-Loss

The price at which a trader exits their position if the trade goes wrong – it limits their potential losses.

Stock Market Hours

• Regular Trading hours: 9:30am to 4:00pm EST, Monday through Friday
• Pre-Market hours: 4:00am to 9:30am EST, Monday through Friday (may vary depending on individual broker)
• After-Market hours: 4:00pm to 8:00pm EST, Monday through Friday (may vary depending on individual broker)
• Stock Market Closed: The market is closed on U.S. holidays and weekends.

Options Traders typically trade during regular trading hours. There are pre-market and after-market trading sessions but these hours typically have more limited liquidity and may carry higher risks. Many traders find more liquidity and better price movement during the first hour and last hour of regular trading hours (9:30am to 10:30am EST & 3:00pm to 4:00pm EST).

What time do I trade?

I trade during the first few hours of the regular trading session – anywhere between 9:30am and 1:00pm EST. I like to trade during these hours as they have the highest volume, highest volatility, and intraday trends tend to take place during this time.

Types of Analysis

There are three ways of analyzing stocks which traders use to make informed trading decisions. They include:

1. Fundamental Analysis

This approach involves analyzing the fundamental factors that influence an asset's value, such as financial statements, economic data, federal meetings, industry trends, and company news and earnings. Fundamental analysis aims to determine the intrinsic value of an asset and make investment decisions based on its long-term prospects.

Example: META News – September 29, 2023.

2. Technical Analysis

This method involves studying historical price and volume data to identify patterns, trends, and market behavior. Technical analysts use various tools, such as charts, indicators, and price patterns, to make predictions about future price movements.

Example: META Chart – September 28, 2023.

3. Sentiment Analysis

Market sentiment refers to the overall attitude of investors. It involves monitoring factors like news sentiment, social media sentiment, and market sentiment indicators to assess the overall market mood.

Example: META Sentiment – September 28, 2023.

Which type of analysis do I use?

My trades are highly based on technical analysis. Though I do look at fundamentals and overall stock market news, I still wait for a technical set-up to place a trade. I’ve found that even with good news or bad news, prices can move differently from what I’d expect.

Market Participants

There are two main types of market participants – Retail Traders and Institutional Traders. They differ based on the amount of money they trade with.

1. Retail Traders

Individuals who trade with their own funds through brokerages.

2. Institutional Traders

Professional Traders representing large financial institutions like banks, hedge funds, mutual funds, pension funds, insurance companies, businesses, and specialized firms. They have the capacity to move the market due to the significant amounts of capital they control.

II. UNDERSTANDING THE CHART

Candlesticks

A candlestick is a visual representation of price movements for a specific time period, displaying the opening, closing, high, and low prices of a financial asset. A candlestick has a rectangular "candle" shape (body) and may have a wick/shadow.

Components of a Candlestick:

• Body: The wide part of the candlestick, which represents the price range between the opening price (when the first trade was made) and closing price (when the last trade was made) during the given time interval.
• Wicks (Shadows or Tails): The thin lines above and/or below the body that extend to the highest and lowest prices reached during the time interval. They indicate the price range beyond the opening and closing prices.

Types of Candlesticks

• Bullish Candlestick: Indicates positive price movement. The closing price is higher than its opening price, and the candlestick is green.
• Bearish Candlestick: Indicates negative price movement. The closing price is lower than its opening price, and the candlestick is red.

Other Candlestick Types

• Marubozu: A long candlestick with no wicks indicating strong buying or selling pressure. A green marubozu indicates that buyers controlled the price movement (strong buying pressure), whereas a red marubozu indicates that sellers controlled the price movement (strong selling pressure).
• Doji: A candlestick with a very little body, where the opening and closing prices are nearly the same. It suggests indecision or a potential reversal in the price trend. The longer the wicks, the greater the indecision.
• Hammer & Hanging Man: A candlestick with a small body and a long lower wick. Both look identical; the difference is whether price movement is in an uptrend (hammer) or downtrend (hanging man).
• Inverted Hammer & Shooting Star: A candlestick with a small body and a long upper wick; look identical. The inverted hammer occurs at the end of a downtrend indicating a reversal to an uptrend; the shooting star occurs at the end of an uptrend, indicating a reversal to a downtrend.

Candlestick Patterns

Bullish Candlestick Patterns

1. Bullish Engulfing Pattern

   • Type: Bullish, trend reversal
   • Requirements: a smaller bearish candle followed by a larger bullish candle that completely engulfs the previous candle's body.
   • Meaning: Indicates a shift from bearish to bullish.

2. Bullish Harami Pattern

   • Type: Bullish, trend reversal
   • Requirements: a larger bearish candle, followed by a smaller bullish candle within the previous candle's body.
   • Meaning: Signals a potential reversal from bearish to bullish.

3. Morning Star Pattern

   • Type: Bullish, trend reversal
   • Requirements: a large bearish candle, followed by a smaller indecisive candle (bullish or bearish), and a large bullish candle that closes above the midpoint of the initial bearish candle.
   • Meaning: Signifies a potential shift in market sentiment from bearish to bullish.

4. Tweezer Bottom Pattern

   • Type: Bullish, trend reversal
   • Requirements: two consecutive candles reaching the same low point.
   • Meaning: Indicates a shift from bearish to bullish when bears refrain from selling below this lowest price.

5. Three White Soldiers Pattern

   • Type: Bullish, trend reversal
   • Requirements: three bullish candles where each opens above the previous open and closes higher than the previous close without much wick.
   • Meaning: Signals a strong reversal from bearish to bullish.

Bearish Candlestick Patterns

1. Bearish Engulfing Pattern

   • Type: Bearish, trend reversal
   • Requirements: a smaller bullish candle followed by a larger bearish candle that completely engulfs the previous candle's body.
   • Meaning: Signals a shift from bullish to bearish.

2. Bearish Harami Pattern

   • Type: Bearish, trend reversal
   • Requirements: a larger bullish candle followed by a smaller bearish candle within the previous candle's body.
   • Meaning: Signals a potential reversal from bullish to bearish.

3. Evening Star Pattern

   • Type: Bearish, trend reversal
   • Requirements: a larger bullish candle, followed by a smaller indecisive candle and a large bearish candle that closes below the midpoint of the initial bullish candle.
   • Meaning: Signals a potential shift in market sentiment from bullish to bearish.

4. Tweezer Top Pattern

   • Type: Bearish, trend reversal
   • Requirements: two consecutive candles reaching the same high point.
   • Meaning: Signals a potential reversal from bullish to bearish when bulls refrain from buying above this higher price.

5. Three Black Crows Pattern

   • Type: Bearish, trend reversal
   • Requirements: three bearish candles, where each opens lower than the previous open and closes lower than the previous close without much wick.
   • Meaning: Signals a strong bearish reversal.

Chart Patterns

Bullish Chart Patterns

1. Bull Flag Pattern

   • Type: Bullish, trend continuation
   • Requirements: preceding bullish trend followed by downward consolidation, then a breakout above the consolidation channel.
   • Meaning: Indicates a likely continuation of the uptrend as buyers dominate.

2. Ascending Triangle Pattern

   • Type: Bullish, trend continuation
   • Requirements: preceding bullish trend, a horizontal level, and an upward-sloping trendline, then a breakout above the horizontal level.
   • Meaning: Indicates buyers are becoming more aggressive despite resistance.

3. Bullish Pennant Pattern

   • Type: Bullish, trend continuation
   • Requirements: preceding bullish trend followed by a brief consolidation within two converging trendlines, then a breakout above the upper trendline.
   • Meaning: Signals a likely continuation of the uptrend as buyers gain control.

4. Falling Wedge Pattern

   • Type: Bullish, trend reversal
   • Requirements: preceding bearish trend followed by two downward-sloping trendlines, then a breakout above the upper trendline.
   • Meaning: Indicates that declining price trends are weakening while buyers step in.

5. Inverted Head & Shoulders Pattern

   • Type: Bullish, trend reversal
   • Requirements: preceding bearish trend with two shorter peaks of equal height and a middle lower peak that forms a neckline; breakout occurs above the neckline.
   • Meaning: Indicates that bears fail to push the price lower and bulls regain control for a trend reversal.

6. Double/Triple Bottom Pattern

   • Type: Bullish, trend reversal
   • Requirements: preceding bearish trend with two or three equal lows; breakout occurs above the neckline.
   • Meaning: Indicates that selling pressure is finishing and reversal is likely.

7. Cup & Handle Pattern

   • Type: Bullish, trend continuation
   • Requirements: preceding bullish trend, followed by a rounded bottom (cup) and then a pullback (handle), leading to a breakout above the handle.
   • Meaning: Indicates buyers gradually regain control after an initial decline.

Bearish Chart Patterns

1. Bear Flag Pattern

   • Type: Bearish, trend continuation
   • Requirements: preceding bearish trend followed by upward consolidation; breakout occurs below the consolidation channel.
   • Meaning: Indicates likelihood of downtrend continuation.

2. Descending Triangle Pattern

   • Type: Bearish, trend continuation
   • Requirements: preceding bearish trend, a horizontal level, and a downward-sloping trendline; breakout occurs below the horizontal level.
   • Meaning: Signals sellers are becoming aggressive despite support.

3. Bearish Pennant Pattern

   • Type: Bearish, trend continuation
   • Requirements: preceding bearish trend with a brief consolidation within two converging trendlines, breakout occurs below the lower trendline.
   • Meaning: Indicates a likely continuation of the downtrend.

4. Rising Wedge Pattern

   • Type: Bearish, trend reversal
   • Requirements: preceding bullish trend with upward-sloping trendlines; breakout occurs below the bottom trendline.
   • Meaning: Indicates rising price trend is weakening.

5. Head & Shoulders Pattern

   • Type: Bearish, trend reversal
   • Requirements: A preceding bullish trend with two shorter peaks of equal height and a middle higher peak; breakout occurs below the neckline.
   • Meaning: Indicates bulls fail to push price higher and bears take control, signaling a trend reversal.

6. Double/Triple Top Pattern

   • Type: Bearish, trend reversal
   • Requirements: preceding bullish trend with two or three equal tops; breakout occurs below the neckline.
   • Meaning: Indicates buying pressure is finishing, signaling a potential reversal.

Support & Resistance

Support and Resistance levels are critical as they provide traders with valuable information about potential entry and exit points – they indicate where potential buyers and sellers are sitting. Drawing these levels using zones and not lines is preferable since price doesn’t always go to the exact same point, but within an approximate area – this includes wicks and bodies of candles.

Support

It's like a floor that prevents the price from falling further. It's a level where buyers tend to step in and create demand, causing the price to stop or reverse from downward movement to upward movement. Traders often see support levels as potential buying opportunities if it bounces off or a selling opportunity if it breaks.

Resistance

It's like a ceiling that prevents the price from rising further. It's a level where sellers tend to emerge and create supply, causing the price to stop or reverse from upward movement to downward movement. Traders often see resistance levels as potential selling opportunities if it bounces or a buying opportunity if it breaks.

How to find Support and Resistance?

Identify key price levels at which the stock has historically shown a tendency to stall or reverse. The more vertical the price movement away from this level, the stronger the area of support/resistance. If price comes back to this strong rejection area, it has a high likelihood of rejecting again. The more times a support or resistance level is tested/touched, the weaker it gets and the higher the likelihood of a breakout.

Common Types of Support and Resistance:

1. Horizontal level: Look for areas where price has previously moved away from multiple times.
2. Trendline: Consists of connections of highs and lows of price movement. If above price, acts as resistance; if below price, acts as support.
3. Psychological Level: Round numbers or key price levels that traders pay significant attention to. E.g. $50, $100, etc.
4. Moving Average: Provides support if below price; may act as resistance if above price.
5. Gap: Gaps on a chart can act as support or resistance levels when price retraces back to the area.

Will price reject or break support/resistance?

We can’t always predict whether prices will reject or break these levels. However, educated assessments can be made by looking at multiple price movements which show a higher probability in a certain direction. The more confluences, the better. You look for:

1. Candlesticks: Look for strong rejection signals for potential reversals.
2. Chart Patterns: Look for bearish or bullish patterns that suggest continuation/reversal.
3. Volume: Higher volume during a breakout indicates a stronger move.
4. Indicators: Depending on the indicator, crossovers or divergences may indicate a reason to buy/sell.
5. News: Major events can influence reactions in the stock market.
6. Time Frames: Direction on bigger time frames matching smaller time frames increases trend probability.
7. Confirmation: Wait for follow-up price movement for confirmation.

Trendlines

Trendlines are lines drawn to visually represent the direction and strength of a trend. They connect consecutive higher swing lows in an uptrend or consecutive lower swing highs in a downtrend. A valid trendline consists of at least three touches; if price breaks a trendline and comes back inside, it is not valid. Adjusting a trendline where price touches allows for more accurate trend following.

Gaps

Gaps occur when there is a significant difference between the closing price of a trading day and the opening price of the following trading day. These gaps can act as support/resistance or get filled – meaning price retraced back to the closing price of that trading day before the gap.

Types of Gaps:

1. Common Gap: Small gaps that do not result from any major event and fill relatively quickly.
2. Breakaway Gap: Occurs when price gaps over a support or resistance area, signaling a trend continuation.
3. Runaway Gap: Indicates strengthening trend as it is a large gap with prolonged movement in the trend direction.
4. Exhaustion Gap: Occurs towards the end of an uptrend or downtrend.

Market Structure

Market structure provides insights into the market's dynamics, revealing the current state, trends, and key price levels such as support and resistance, as well as identifying swing highs and lows.

Bull Market

In a bull market, the structure typically displays a series of higher highs and higher lows, showing a prevailing uptrend with buyers displaying increased strength and confidence.

Bear Market

Conversely, in a bear market, the structure generally features lower highs and lower lows, showing a downtrend where sellers are gaining control, resulting in deeper declines.

Trading Styles

There are three distinct approaches to trading – Scalping, Day Trading, and Swing Trading.

1. Scalping: Making quick trades to profit from small price movements, typically holding positions for a few seconds to minutes.
2. Day Trading: Trading within the same day (intraday), aiming to capture short-term price movements while closing positions before the day ends. Positions are held from minutes to hours.
3. Swing Trading: Holding trades for a few days, weeks, or months targeting larger price moves within the overall trend.

Which trading style is best?

Each style depends on goals, risk tolerance, time availability, and strategy.

• Scalping: If you can process information fast and make quick decisions.
• Day Trading: If you can commit several hours daily and are comfortable with intraday trends.
• Swing Trading: If you're limited on time, seek price swings, and are okay with overnight changes.

What’s my trading style?

Scalping. I have quick decision-making skills, process information fast, prefer short moves, and aim for fast returns.

Trends vs. Consolidation

Trending

Means the underlying asset is experiencing clear and sustained movement in a specific direction, either up or down, providing potential opportunities for traders to profit.

Consolidation

Refers to a period where the price moves within a relatively narrow range or sideways pattern, indicating a temporary equilibrium between buying and selling pressures.

Indicators

Indicators are tools or metrics used to analyze the market and develop trading strategies. They help assess price trends, volatility, momentum, and other factors potentially impacting options prices.

• Most indicators are lagging; they do not predict the future. They should be used in conjunction with price action analysis.

Common Types of Indicators:

1. Volume Weighted Average Price (VWAP): Shows average price based on both price and volume.
2. Moving Average (MA): Smooths price fluctuations; includes Exponential (EMA) and Simple Moving Average (SMA).
3. Relative Strength Index (RSI): Measures speed and change of price movements; indicates overbought (above 70) and oversold (below 30) conditions.
4. Bollinger Bands: Measures volatility; indicates potential reversal points.
5. Moving Average Convergence Divergence (MACD): Shows relationship between two moving averages; identifies trend direction and potential entry/exit points.
6. Stochastic Oscillator: Compares closing price to price range, indicating overbought or oversold conditions.
7. Volume: Measures the number of shares/contracts traded; confirms price movements.

What indicators do I use?

I focus on three indicators – 9 EMA, VWAP, and Volume. They guide my trading rather than overshadowing market movements.

III. OPTIONS PRICING

The Greeks

The Greeks quantify various factors influencing the price and behavior of options. They affect the price of options contracts as well as their value in an open position.

1. Delta

Delta measures the rate of change in the option price in relation to changes in the price of the underlying asset. E.g. If you buy a call option for $300 with a delta of 0.50 and the stock increases from $60 to $61, the option is worth $350 (you made $50).

2. Theta

Theta measures the rate of decline in the value of an option as it approaches expiration. E.g. If you buy a call option for $200 with a theta of 0.50, it’s expected to decrease by $50 over a day.

3. Gamma

Gamma measures the rate of change in an option's delta in response to changes in the stock price. E.g. Delta starts at 0.40, and gamma is 0.10; if the stock increases from $205 to $206, delta becomes 0.50.

4. Vega

Vega measures the expected change in the option's price for a 1% change in implied volatility. E.g., Vega of 0.05 with an implied volatility of 10% means if volatility increases to 11%, the option's value rises to $205.

5. Rho

Rho measures the expected change in the option's price for a 1% change in interest rates. E.g. Rho of 0.50 means if interest rates climb from 5% to 6%, the option's value increases by $50.

Which Greek is the most important?

It depends on your trading strategy. As a scalper, delta matters most for quick responses to stock changes to capture fast profits.

Risk Management

Risk Management involves strategies and techniques to control and mitigate potential losses. This includes assessing risks to protect capital and preserve trading profits.

Key Principles:

1. Position Sizing: Determine the size of each trade relative to overall capital. E.g., with a $2,000 account, risk 2.5% per trade.
2. Stop-Loss Order: Set an order to limit losses at a specific price level.
3. Risk/Reward Ratio: Evaluate potential loss versus potential gain; aim for trades with a favorable ratio.

How I managed risk as a beginner?

I started with $7,000 as practice money, bought 1 contract at a time, and focused on managing losses with tight stop-losses.

Trading Plan

Essential for executing trades appropriately; includes three components:

1. Entry: Define conditions triggering a trade.
2. Stop-Loss: Set a limit for exiting to prevent significant losses.
3. Exit: Determine when to close trades based on profit targets or signals.

Types of Orders

Several types of options orders to execute trades. Common Types:

1. Market Order: Buy/sell at the best available price.
2. Limit Order: Set a specific price for buy/sell.
3. Stop Order: Becomes a market order at a certain level for protection.
4. Stop-Limit Order: Similar but includes a limit on your price.
5. Trailing Stop Order: Moves with the market price to protect profits.

Which order type to choose?

Market and limit orders are commonly used; focus on these for ease at first. As a scalper, I prefer market orders for quick fills.

Types of Strike Prices

Options are classified based on their strike prices relative to the underlying asset's current market value:

1. In-The-Money (ITM)

Options with intrinsic value favorable for the holder. E.g., Call option where the stock price is higher than the strike price.

2. Out-Of-The-Money (OTM)

Options with no intrinsic value; require favorable movements to become profitable. E.g., Put option priced above the underlying asset.

3. At-The-Money (ATM)

Options where the current price is equal/close to the strike price, representing a neutral position.

Cost of Trading

Various factors influence option contract prices:

1. Underlying Asset Price Movements
2. Time Decay
3. Expiration Date
4. Volatility
5. Interest Rates
6. Market Sentiment

IV. PUTTING IT TOGETHER

Psychology vs Knowledge

Quote: “Trading is 20% knowledge and 80% psychology.”
Psychological factors greatly influence trading success alongside knowledge.

Trading Psychology

Refers to the mindset impacting traders’ decision-making.

1. Fear: Fear of losses leads to hesitation.
2. Greed: Can prompt impulsive decisions.
3. Overtrading: Excessive trading often results from impatience.
4. Revenge Trading: Trying to recover losses leads to more risk.
5. Loss Aversion: Pain of losses leads to holding losing positions too long.
6. Fear of Missing Out (FOMO): Can push traders into poor trades.
7. Overconfidence: Leads to risky decisions.
8. Lack of Discipline: Deviating from strategies leads to erratic behavior.

How to practice good psychology?

Develop self-awareness and identify areas to improve. Start with small goals to build toward greater progress.

Price Action

Refers to analyzing price movement on a chart to make trading decisions. It's about understanding market direction based on historical price behavior without heavy reliance on indicators.

How to learn Price Action:

1. Study basics of candlesticks, patterns, support and resistance.
2. Analyze charts in real-time across different time frames.
3. Identify reasons for strong/weak buyer/seller areas.
4. Draw trendlines for trend direction.
5. Use helpful indicators to complement price action, not overpower it.
6. Backtest historical movements to refine understanding.

V. STARTING YOUR TRADING JOURNEY

Getting Started

Steps to initiate Options Trading:

1. Educate Yourself: Use various resources to learn.
2. Brokerage Account: Open an account with your preference.
3. Funding Your Account: Be comfortable with the amount you invest.
4. Charting Platforms: Choose one that fits your style (I use TradingView).
5. Paper Trading: Practice without risking real money for experience and confidence.
6. Developing Strategies: Establish a plan outlining goals and rules.
7. Risk Management: Apply techniques to protect from losses.
8. Stay Informed: Regularly review news and market trends.
9. Continuous Learning: Keep improving skills and knowledge in trading.

Paper Trading vs. Live Trading

Paper Trading

• “Fake” money
• Useful for practicing/training

Live Trading

• “Real” money
• Involves actual gains/losses
• Provides real emotional impacts

Which should a beginner choose?

Live trading offers comprehensive learning due to exposure to real emotions and challenges.

Trading Routine

Establish a trading routine for consistency:

1. Before: Review current news and set up for trading day.
2. During: Stick to strategies and monitor watchlist.
3. After: Review trades and learn from performance.

Stock Selection

Choosing the right stocks is critical; consider their historical performance, liquidity, and compatibility with your strategies.

Questions to Ask:

1. How does the stock typically move?
2. Is there a technical setup?
3. What’s the level of volume/volatility?
4. Are you updated on financials?

What stocks do I trade?

I prefer large-cap stocks with high liquidity and volatility to enhance execution effectiveness.

Buying & Selling Contracts

Familiarize with your brokerage's platform. Steps to Execute Trades:

Buying a Contract

1. Click the ‘Trade’ tab and find the ticker.
2. Select expiration date and choose desired contract.
3. Review and execute the trade.

Selling a Contract

1. On ‘Positions’ tab, select the contract, and choose to sell.
2. Review and confirm the trade.

Backtesting & Journaling

Backtesting simulates trades based on historical data to learn without risking capital. Journaling records experiences to enhance future decision-making.

### Spend 1-2 hours a day backtesting to improve trading skills to achieve consistent results.

Quitting a 9-5 Job

Transitioning to full-time trading requires careful planning:

1. Ensure strong understanding of options.
2. Maintain a financial cushion during transition.
3. Have clear financial goals and a contingency plan for losses.
4. Factor in healthcare and tax implications when becoming self-employed.

Conclusion

As you finish reading this book, I’d like to leave you with a powerful concept: Getting 1% Better Each Day!
Success in Options Trading is about consistent, gradual improvement. Don't be discouraged by setbacks—show up, learn, and trust the process!