# New to Options trading - Appreciate your help



## aarbee (13 February 2013)

Good day,
I am paper trading Options on US ETFs on Interactive Brokers platform. I am an Options newbie and my aim is to trade long Calls or long Puts instead of the underlying ETFs. I have chosen very liquid set of ETFs to trade.  I intend to paper trade till I am comfortable with it and actually understand the nuances of trading Options, especially the "not so apparent" risk factors that can bite unexpectedly.

The holding period of my trading system (EOD) is 2-10 days, though some (very few) trades can go upto a month or longer.

I would like help on the following:  

AA   My initial thoughts are to buy ITM Calls/Puts expiring 2 months from now. Is it the way to go. 

BB   Mechanics of deciding on the moneyness of the chosen Options and which option levels to go for, i.e. how far in the future and how deep in the money. 

CC   I am studying the effect of Delta in deciding on the Options to trade. I note that Delta for longer term ITM options is lower than the shorter term options. Thus, the longer term options will be less profitable for the same favourable move in the underlying ETF. What is the downside to trading shorter term Options. I understand that time decay will erode the value for very short-term options. 

DD   How important is OI in decision making.

EE   Are there any other factors that I should be looking at or be wary of.

Will appreciate comments from the experienced Options traders on the forum.

Cheers


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## baby_swallow (13 February 2013)

Try books by S Natenberg and L MacMillan. 
You can probably find the answers to most of your questions and more....

I tried trading simple options (ie. buying Calls or Puts) many years ago with not much luck.
So I decided to just trade straight futures. 

Now, with the availability of sophisticated softwares and online brokers, I'm tempted  to have another go.
But this time, I will be looking at those options spreads with fancy names.

Good luck.


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## cbc1 (14 February 2013)

Hi Aarbee,

Happy to help,  after your first few months trading you will start to become comfortable trading options.

I'm up around 400% from the 1/7/2012....... so ere we go

Aa : I can't really give advice on what to buy or what to look for whether ITM is a good buy,  if you mean the code ITM.  If you look at most option tables you can see that most traffic (trades) happens in the last month.  You could look at 2 months just as a starter tho.  Considering it is your first trade.

Bb : M8...... I'm going to save you a lot of money.....  buy in "at the money" for your first trade.  You can look at other options l8r.  Most trades happen in the last months of the expiry...... because..... you may as well get it over and done with real quick.  Also if you purchased an option 1 month from expiry and another 2 months from expiry with the same exercise price and the market (underlying asset) moved in your favor say 1% there would be a fair difference in the profit of the 1 month compared to the 2 month..

Cc: Don't know much about the delta

Dd: oi?

Ee: Yer M8, stop the paper trading and get on with it.  After your trades go over what happened,  especially your winning trades.  Why you chose that position n stuff.  Then you can develope a system that you can constantly profit from.  Trade at the money..

Best of luck.


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## wayneL (14 February 2013)




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## sails (14 February 2013)

wayneL said:


>





Wayne, I wondered how you would handle it...

Arbee, there are no simple answers to your questions - it's a case of "it depends" on the greeks and volatility is an important one - as is delta and gamma.


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## aarbee (15 February 2013)

Thanks Sails, Wayne, Swallow,

I have ordered the McMillan book on Options and hope to receive it early next week. 
Will go through it and will surely have a lot more questions for you all. 

Best regards


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## statmech71 (15 June 2013)

I have what is probably a very basic question relating to options:

What happens if one holds onto an options contract that is in the money after expiry? Does it lose all of its value or can it still be executed, or maybe even traded?

Thanks in advance.


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## sails (15 June 2013)

statmech71 said:


> I have what is probably a very basic question relating to options:
> 
> What happens if one holds onto an options contract that is in the money after expiry? Does it lose all of its value or can it still be executed, or maybe even traded?
> 
> Thanks in advance.




If you are short an ITM option, you can expect it to be assigned leaving you short the shares of the underlying which will show up in your account the next morning. 

 If you are long an ITM option, your broker will probably have it auto exercised leaving you long shares which will show up in your account the next morning.

If it isn't auto exercised, then you lose any value remaining in it and the person holding the other side (short) gets to keep the premium (lucky him!).

Expiry day is the last day you can trade an option and the last day you can request any ITM options be exercised.

Now all that is based on stock options.  If you are talking about index options, they are different again in that they are cash settled on the morning of expiry day.  Although they continue to trade until around 12md, the spreads are horribly wide and there is next to no trading done on that day as the settlement price is known soon after the ASX200 stocks have opened. The day before expiry is the last practical day to trade index options, imo.  Even then, all the deals have to be done prior to expiry of the contract.

Does that help?


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## statmech71 (15 June 2013)

Thanks sails, very helpful.


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## sails (15 June 2013)

statmech71 said:


> Thanks sails, very helpful.




You are welcome...  I still remember struggling with basic info like this when I started out in options.


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## Sharkman (16 June 2013)

if you are going to let long calls on stock expire, you might want to be careful. either make sure you have enough cash to take delivery of the stock, or you know exactly what your broker's policy is. i remember reading a story once (though it may be just that - a story - i don't know the trader involved and therefore can't confirm it myself) where someone held ITM long calls thru to expiry and nothing happened. when he asked the broker they said you don't have enough cash to buy the stock at the strike price, so we told the OCH to abandon your options. the trader had assumed the broker would have exercised the options and bought the stock for him, then immediately sold it off at market price to get his account back above 0. arguments got him nowhere.

so if that is true, ITM options can indeed lose all their value after expiry if you're not careful...


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## sails (16 June 2013)

Sharkman said:


> if you are going to let long calls on stock expire, you might want to be careful. either make sure you have enough cash to take delivery of the stock, or you know exactly what your broker's policy is. i remember reading a story once (though it may be just that - a story - i don't know the trader involved and therefore can't confirm it myself) where someone held ITM long calls thru to expiry and nothing happened. when he asked the broker they said you don't have enough cash to buy the stock at the strike price, so we told the OCH to abandon your options. the trader had assumed the broker would have exercised the options and bought the stock for him, then immediately sold it off at market price to get his account back above 0. arguments got him nowhere.
> 
> so if that is true, ITM options can indeed lose all their value after expiry if you're not careful...





Moral of that story is never assume anything - always check with your broker if unsure!

Yes I have read stories of people who have been long options and got into horrible strife because they forgot it was expiry or didn't understand that some brokers auto exercise when it's itm by a tiny amount. We need to know our brokers policies on this - some might also charge fail fees if there is insufficient funds in the account to buy the shares. It is possible to let your broker not to auto exercise if its not worth trading out on expiry day.


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## statmech71 (17 June 2013)

Sharkman said:


> if you are going to let long calls on stock expire, you might want to be careful. either make sure you have enough cash to take delivery of the stock, or you know exactly what your broker's policy is. i remember reading a story once (though it may be just that - a story - i don't know the trader involved and therefore can't confirm it myself) where someone held ITM long calls thru to expiry and nothing happened. when he asked the broker they said you don't have enough cash to buy the stock at the strike price, so we told the OCH to abandon your options. the trader had assumed the broker would have exercised the options and bought the stock for him, then immediately sold it off at market price to get his account back above 0. arguments got him nowhere.
> 
> so if that is true, ITM options can indeed lose all their value after expiry if you're not careful...




That's exactly the situation I've contemplated and wanting to avoid. I don't know what my broker's policy is, but I'll be finding out. Thanks again for your help


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## Newtotrading (30 July 2013)

Hi Everyone, I am new to Options although I have been trying to do paper trading credit spreads with optionsxpress on the RUT. I did some of the Optionetics course, which I learnt a little of everything and nothing I feel confident in, so I am concentrating on learning credit spreads at the moment.  Can anyone suggest someone/platform that does the Australian Market, as optionsxpress only does US.  Any imput or direction I would 
sincerely appreciate, as it is all becoming very confusing at the moment.  Regards  Anne-maree


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## Sharkman (31 July 2013)

Newtotrading said:


> Hi Everyone, I am new to Options although I have been trying to do paper trading credit spreads with optionsxpress on the RUT. I did some of the Optionetics course, which I learnt a little of everything and nothing I feel confident in, so I am concentrating on learning credit spreads at the moment.  Can anyone suggest someone/platform that does the Australian Market, as optionsxpress only does US.  Any imput or direction I would
> sincerely appreciate, as it is all becoming very confusing at the moment.  Regards  Anne-maree




don't know about platforms for paper trading ASX ETOs, but when you're ready to start trading the real thing, in my view there is only one choice for trading ASX ETOs: interactive brokers

when i first started trading ASX options 4 or 5 years ago every single aust broker i found was a ripoff. 0.60% brokerage here, $55 minimum brokerage there, etc. IB was the exception. just $3 a contract (this was back in the days of 1000 contract sizes) with a minimum of $3. these days it's even better as it's only 30c a contract with a minimum of $2

don't sign up until you're ready to start trading live though, as there is a monthly minimum activity fee (USD 10 or something like that)


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## Newtotrading (31 July 2013)

Sharkman said:


> don't know about platforms for paper trading ASX ETOs, but when you're ready to start trading the real thing, in my view there is only one choice for trading ASX ETOs: interactive brokers
> 
> when i first started trading ASX options 4 or 5 years ago every single aust broker i found was a ripoff. 0.60% brokerage here, $55 minimum brokerage there, etc. IB was the exception. just $3 a contract (this was back in the days of 1000 contract sizes) with a minimum of $3. these days it's even better as it's only 30c a contract with a minimum of $2
> 
> don't sign up until you're ready to start trading live though, as there is a monthly minimum activity fee (USD 10 or something like that)




Thank you so much for your help.  I will look into IB.   Anne-Maree


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## sails (31 July 2013)

Newtotrading said:


> Thank you so much for your help.  I will look into IB.   Anne-Maree




Anne-Maree, IB has a demo account for paper trading Australian ETOs but you have to have a funded IB account with approval for options trading and I think you also need to pay for Aussie data.  There is a link somewhere to set up the demo account, but no point in doing it until the live account is fully set up.

The options paper trading is not as good as live trading, but it gives one practice with the software.  For example I have found you have to buy at the ask and sell at the bid to get an order to go through on the demo account.  You can see how their accounting system works and how margins work.  If you are new to options trading, I would suggest you become very familiar with the demo account first as IB are not there for hand holding new traders!

If you are willing to pay higher brokerage, Trader Dealer have been pretty good with options although I had to phone or email spread orders through - that was at least three or more years ago so don't know if they have changed their system. And you would need to talk to them to find out if they are OK with credit spreads.

If you are fairly confident and understand that IB can liquidate your positions randomly if you have insufficient funds for margin, then IB is certainly cheaper with much more sophisticated software. Just keep a very close eye on margins if you have a small account.  The other thing to watch with IB is if you are assigned on a short option - they give you the first 10 minutes to get out of the position before the system starts randomly liquidating your positions.  There's no free lunch...


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## Newtotrading (31 July 2013)

sails said:


> Anne-Maree, IB has a demo account for paper trading Australian ETOs but you have to have a funded IB account with approval for options trading and I think you also need to pay for Aussie data.  There is a link somewhere to set up the demo account, but no point in doing it until the live account is fully set up.
> 
> The options paper trading is not as good as live trading, but it gives one practice with the software.  For example I have found you have to buy at the ask and sell at the bid to get an order to go through on the demo account.  You can see how their accounting system works and how margins work.  If you are new to options trading, I would suggest you become very familiar with the demo account first as IB are not there for hand holding new traders!
> 
> ...




Thank you for all that information and help with IB   I am pleased they have a demo account and will look into it all today.   Anne-Maree


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## Sharkman (31 July 2013)

i would also (and this is just personal opinion, others may disagree) suggest starting out with DEBIT spreads rather than credit spreads. debit spreads i think are safer for newcomers (compared to credit spreads) because the max risk of the position is paid in its entirety up front, so you're less likely to get into trouble with collateral etc.

getting a feel for your risk in credit spreads will become second nature after a short while, but when first starting out, it is quite possible to get it wrong and wind up overextending your trading account.

in my opinion the main focus when first starting out in options should not to be to make the max profit possible, but rather, it should be to make sure you don't blow up your entire trading account during the learning process. something that is very easy to do with leveraged derivatives if you're not careful, especially with IB where there is no level 1, level 2, level 3 etc. permissions, like there are with some aust brokers, that function to restrict the types of strategies you can do. in contrast, as soon as your IB account has options trading approval, they give you all the toys to play with. yes, they will let you sell a naked call (if for some unfathomable reason you actually wanted to do that) provided it meets the initial margin. i know this for a fact, as when i was first starting out in options, i crazily tried to leg into a call spread by going for a fill on the short leg first, as i thought the underlying was about to "ease off a bit" and i could get the long leg filled more cheaply. so i essentially had a naked call for several very uncomfortable minutes as i watched the thing keep rallying. never again. free tip - DON'T DO THAT!

so yes you get all the toys straight away at IB but it's a double edged sword because as soon as you fail to meet your margin requirements - and they calculate that in real time, not just on an end-of-day basis - as sails said, you're given a few minutes notice before they start closing down positions randomly. so you must be careful and IMHO sticking to debit spreads, at least at first, is one way to do that.


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## wayneL (1 August 2013)

Sharkman said:


> i would also (and this is just personal opinion, others may disagree) suggest starting out with DEBIT spreads rather than credit spreads. debit spreads i think are safer for newcomers (compared to credit spreads) because the max risk of the position is paid in its entirety up front, so you're less likely to get into trouble with collateral etc.
> 
> getting a feel for your risk in credit spreads will become second nature after a short while, but when first starting out, it is quite possible to get it wrong and wind up overextending your trading account.
> 
> ...




IBs margin rules take care of that though. Also, (presuming we are talking OTM credit spreads) IME the bid/ask spreads are usually higher in the equivalent debit spread.

Synthetically equivalent yes, but higher contest risk.


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## omad (1 August 2013)

Sharkman said:


> i would also (and this is just personal opinion, others may disagree) suggest starting out with DEBIT spreads rather than credit spreads. debit spreads i think are safer for newcomers (compared to credit spreads) because the max risk of the position is paid in its entirety up front, so you're less likely to get into trouble with collateral etc.
> 
> getting a feel for your risk in credit spreads will become second nature after a short while, but when first starting out, it is quite possible to get it wrong and wind up overextending your trading account.
> 
> ...




For the sake of the discussion I'll partially disagree, I think starting out with defined risk trades is a good idea for beginners but I don't think debit spreads are better then credit spreads. 

Credit spreads are defined risk just like debit spreads so once entered your margin requirements don't change, even if the underlying goes through your strikes, so no need to worry about margin calls, your max loss is the width of the strikes less the credit received and this is all your broker will hold as margin. If your using correct position size then you won't blow up your account.

I would prefer to trade credit spreads over debit spreads due to the higher probability of success but when volatility is low debit spreads are the way to go. This is what beginners should be focused on, when to use which strategy.

As for naked calls (and puts), if your happy to short (or buy) stock then there's no reason not to sell naked calls (or puts), again as long as you're using correct position size you are controlling your risk, most people get into trouble by trading too big. Margin requirements will change with naked options as the underlying moves so they definitely need more managing then spreads, once open I don't touch spreads other then to close for profit, if it goes against me I'll let it go. Every month I have spreads go to max loss. If you're getting margin calls/positions closed I would say you're trading to big.


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## Newtotrading (1 August 2013)

wayneL said:


> IBs margin rules take care of that though. Also, (presuming we are talking OTM credit spreads) IME the bid/ask spreads are usually higher in the equivalent debit spread.
> 
> Synthetically equivalent yes, but higher contest risk.




Thanks everyone,  I am certainly taking it all in.  I have just started to papertrade with Optionsxpress doing OTM credit spreads with a stop loss on RUT.   I will be cautious with IB and make sure I know risks etc when I trade with them. I will definitely learn debit spreads, I am just trying to learn one thing at a time and understand it completely.   Thanks again.  Anne-Maree


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## Sharkman (1 August 2013)

very good points. but to be fair, i'm not arguing that debit spreads are better than credit spreads, or vice versa. as you said, there are situations to do debit spreads and there are situations to do credit spreads. but i do think debit spreads are a safer strategy *when one is first starting out trading options* for the reasons i mentioned.

personally i never do naked calls. sure most of the time you won't get burned, but what if you were short naked calls on rio tinto, back in 2007 i think it was? that could have blown you out of the water right there. position sizing can help, but i prefer to just protect the upside risk by buying OTM calls. helps me sleep at night. plus i find most of the time the delta skew just begs me to do it anyway, with typically dirt cheap IV at the higher strikes. to each his own though.


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## wayneL (2 August 2013)

omad said:


> I would prefer to trade credit spreads over debit spreads due to the higher probability of success but when volatility is low debit spreads are the way to go. This is what beginners should be focused on, when to use which strategy.




Agree with the rest of your post, but when comparing credit spreads to debit spreads we are both making assumptions that need clarification.

I don't know whether that is what he meant, but in my assumption Sharkmans suggestion is using the equivalent debit spread, ie same strikes and expiry. 

In your assumption a credit spread is constructed OTM (eg say a put spread with a OTM short put and further OTM long put) and a debit spread ATM (eg say a call spread with slightly ITM long call and slightly OTM short call). There are good reasons why this is generally the way things are done for the given profiles, but for NTT's edification this needs to be made clear.

IOWs OTM credits spreads and ATM debit spreads are two different beasts that should not be compared in the same situation. An OTM credit spread is almost purely a premium collection strategy (notwithstanding other considerations) whereas an ATM debit spread is a directional play.


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## omad (2 August 2013)

WayneL, You're right, I was comparing OTM credit spreads to ATM debit spreads as that's what I trade. If Sharkman is comparing same strikes then no difference in probability of success. My point was debit spreads are no "safer" then credit spreads, your loss is still the same if the trade goes against you. If he was referring to the beginner trader being able to understand their position easier then sure, I can see this.

Sharkman, short calls in RIO would have hurt for sure, if your position was small enough it could have been managed. Stock jumped $30 then a couple of months later was down $36. I find naked positions easier to manage then spreads, if I'm wrong with spreads I very rarely make adjustments but I'm very aggressive with adjustments in naked positions.

In saying that at the moment due to low Vol I have very few naked positions on, can't wait to get some Volatility back in the market.


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## Sharkman (2 August 2013)

omad said:


> If he was referring to the beginner trader being able to understand their position easier then sure, I can see this.




yep that is the point i was trying to make. sorry if this was unclear. i wasn't advocating trading the synthetically equivalent debit spread if Anne-Maree finds a good opportunity to use a credit spread, but rather, to try and identify opportunities conducive to the use of debit spreads, and trade those instead. at least at first.

you guys have probably (definitely in wayne's case) been trading options for longer than me so you might have forgotten what it was like when first starting out. a newcomer could mistakenly assume, i have one bought and and one sold leg of equal size, therefore the former is hedging the latter, ok sweet i can use the remainder of my account to put on new positions - only to misjudge the max risk of the credit spread, then get margin called when they do put on new trades and the market moves against both. i think IB use reg-T margin calcs for ASX options, even if your account is portfolio margin, so the entire distance between the strikes has to be stumped up as collateral. don't know for sure though as i do everything fully cash covered for the moment.


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## omad (3 August 2013)

I don't trade ASX so not sure how IB handle margin on spreads, it's probably on their site somewhere.


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