I’ve said it before and I’ll say it again … if you trade options like stocks, you’re setting yourself up for failure.
But it’s not always easy to grasp the distinctions between stocks and options, especially for those who haven’t been trading for very long…
Stock traders often ask me how they can transition to options trading without blowing their accounts up.
And today, I’m going to share my answers with you.
So, keep reading to see everything you need to know about trading stocks vs. options…
The Key Differences Between Stocks and Options
When you trade stocks, you’re temporarily buying a piece of a company, becoming a shareholder.
Your trades’ success depends on the share price increasing over time. It’s that simple.
Options, on the other hand, work differently…
An option is a contract that gives you the right, but not the requirement, to buy or sell a stock at a certain price within a specific time period.
Options come in two main types: calls and puts. A call option gives the right to buy, while a put option gives the right to sell.
Unlike stocks, options have expiration dates, and if they’re not used by then, they become worthless.
So, what does all of this mean for traders?
In general, options move faster than stocks, amplifying your potential for quick gains and losses.
Many traders come to options expecting that they can trade the same strategies they did with stocks and make more money faster without changing anything.
But let me tell you why this isn’t the case…
The Dangers of Mixing Strategies
Trying to trade options the same way you trade stocks can lead to serious trouble and brutal losses.
While stocks can be held as long as you’d like … options expire, and time isn’t on your side.
Also, because options can multiply gains and losses, trading options requires more careful risk management than regular stock trading.
For example: A small dip in the share price that would’ve been easily manageable on a stock trade could cause your weekly call option to lose 50% of its value in minutes.
Options trading isn’t just about predicting the stock’s direction…
You also need to correctly guess when the movement will happen and how big the price changes will be.
Let’s get more specific…
6 Things to Consider When Transitioning from Stocks to Options
Here are six key areas to focus on if you’re a stock trader looking to explore the options market:
1. Time Decay
The two most important aspects of options trading are direction and time.
Intrinsic value covers direction … but what about the time value of your contracts?
Time value is the extrinsic value of any options contract … it’s what you’re paying for as an options trader.
The more time is left before your contract’s expiration date, the higher its extrinsic value (and overall premium) will be.
Options lose value as time passes, which is known as time decay.
Traders of options not only need to pick the right direction but also guess when the change will happen.
2. Volatility Matters
Volatility, or how much a stock’s price changes, has a big impact on options prices.
In the options market, implied volatility (IV) is an estimate of a stock’s future volatility. It reads as a % figure attached to options contracts.
Understanding IV is crucial. Both puts and calls are more expensive if the contract’s IV is higher.
On the flip side, if a chart looks like a flat line with few price swings, the IV on those options will likely be lower (and the contracts less expensive).
3. Choosing the Right Position Size
Options can quickly multiply gains and losses.
Choosing a position size that fits your risk tolerance is vitally important to make sure you can get through unsuccessful trades without losing too much.
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You also need to know when to size up and get aggressive on perfect patterns.
If you’re leaving a lot of money on the table, so to speak, it will be far more difficult to compound gains and grow your account exponentially.
4. Choosing the Right Strike Price
Selecting the right strike price, especially considering how you think the stock will perform, is key in options trading.
Try to choose a strike price that will deliver solid returns if you’re correct about the timing and direction of the underlying stock, but won’t lose 70% of its value in minutes if you’re wrong.
For me, this generally means avoiding zero-days-to-expiration (0DTE) options and long-dated LEAPs.
The middle ground that works for me? Weekly contracts, usually two to five days out from the time of purchase.
But don’t just take it from me. You must experiment with different strikes to discover what works for you.
5. Understanding the Greeks
In options trading, you’ll hear about the “Greeks” — Delta, Gamma, Theta, and Vega, which represent different kinds of risk in an options position.
The Greeks may sound overwhelming in the beginning, but you can’t sleep on them…
Understanding these formulas is necessary to really grasp how the prices of contracts fluctuate due to external factors.
6. Entries and Exits
With options, you need to know when to enter and exit your positions at the opportune moment.
Holding runners vs. booking profits quickly, for example.
And when you’re up on unrealized gains, you need to protect your profits. This might mean exiting earlier than you expected to keep your gains intact before time decay takes them away.
Or, when you’re stuck in a losing trade (it’ll happen) … the importance of cutting your losses immediately.
Losses can compound much faster with options vs. stocks and you must keep your trades on a short leash for this very reason.
For anyone trading stocks … the options market isn’t out of reach, but trading it requires special considerations and a lot of studying.
Don’t jump headfirst into options without understanding what makes them unique. That’s how you become part of the 90% of traders who fail.
But if you take a cautious and calculated approach to learning a new market, you might find that options open up an entirely new world of trading possibilities.
And speaking of a new world of trading possibilities…
Are You Ready To Take The Next Step?
Here’s the truth … I wouldn’t be a multi-millionaire if I hadn’t joined Tim Sykes’ Trading Challenge so many years ago.
And I want you armed with all of the tools necessary for success in the stock market.
So, if you’re passionate and dedicated, ready to take on anything the market throws at you, then I’ve got something for you…
My mentor, Tim Sykes, has helped traders learn to succeed for years. More than 30 of them (including me) are now millionaires.
Are you ready to take your trading game to the next level? Do you have what it takes to face the Trading Challenge?
Let’s find out…
I’m excited to see you there!