Options—Where Do I Begin? Part 1

Editor’s note: This entry was written by Sean Knudson, a Summer 2012 CBOE Intern in the Options Institute. He is a Senior at Carthage College double majoring in Finance and Music.

Being a college student, I certainly know what it’s like to have a limited amount of capital for spending or investing. That being said I also know what it’s like to not want to get into something with a lot of risk. I’ve found that options strategies can be a great way to participate in the market without putting up a huge amount of capital, and accepting the possibility of large losses. But all of this begs the question: Where do I begin?

The first place to start as with any investment is to learn the basics. There are several low cost ways to find out more about options depending on your learning style and how much time you have to commit. There are hundreds of books written about options. Some are heavy on math; others delve into specific topics like Index options or LEAPS (Long-Term options). If you are a reader like myself, you will want to pick up one of several books: if you’re a beginner you might enjoy “Options as a Strategic Investment” by Lawrence McMillan; for an intermediate options student “Trading Options as a Professional” by Jim Bittman is an excellent choice; and those who have a desire to learn more advanced concepts will find ”Option Volatility & Pricing” by Sheldon Natenburg of great interest. Of course, these are not the only well written books on options.  At first glance they may sound like technical text books that would have complicated language confusing to the average reader, but having been someone who has read all three, I can assure you that each does a great job of explaining not only the basics but in depth strategies as well.

If you are a visual person, the Chicago Board Options Exchange has an archive of free webcasts. Each is taught by a CBOE Options Institute Instructor, or a guest lecturer. They can be found at http://www.cboe.com. Sign up for a free myCBOE account to access the archive. Without signing up, you can watch CBOETV right on the homepage. There are various subjects ranging from basic options strategies to current events, and market volatility.

Another question you might ask is: But how will I know if I’ll be a good options trader, before I commit capital to a trade? Well the truth is you won’t. Market activity changes every day and a good trade today might be a bad trade tomorrow; but that doesn’t mean you can’t practice and discover what strategies best fit your needs and risk level. Doing paper trades is a good way to trade options and other securities without committing capital. There are three paper trading platforms that the CBOE provides. They can be found under the “Tools” menu on the main website. They are: Virtual Trade; paperTrade; paperMoney.

Once you feel comfortable about trading and understand the risks involved with trading listed options, it’s time to open an account! There are several brokerage firms to choose from that offer options trading. Not all brokerage firms have the same capital requirements to open an account, and the kinds of trades they allow you to make will vary, depending on factors such as amount of capital and trading experience. Each firm will provide you with those guidelines before you open an account.

So, I’d suggest learning the basics by picking up a book and watching the educational web videos on the CBOE website. CBOE also has articles that pertain to strategies and option pricing characteristics on their website as well. If you are entirely new to trading, start by paper trading to get your feet wet before you commit your cash. Shop around online for a brokerage firm and ask your friends who trade which one they use. Their personal experiences will shed some light on the realities of trading listed options. When you are ready, put on a small trade. Risking your own money is sometimes the quickest way to learn. Being a college student, cash is often limited, but doing my homework makes me feel rich with knowledge.

As a follow up, I will be writing two more blogs over the next few weeks to help readers with strategies and different factors that affect option prices. Don’t get me wrong, you aren’t going to learn everything in a few blogs. But, the topics discussed will be indispensable when you begin trading, and are a good place to start if you want to go more in depth on any one subject. As with all CBOE blogs, if you have questions, you may send them in to be answered.

(editors note: Sean is no relation to Keith Knudson, the late drummer of the Doobie Brothers, according to Peter Lusk)