On social media like Facebook, Reddit, or Twitter, I keep finding this question all the time: “How to start trading options.” And it can be intimidating to start trading options if you are new to them. Where to start? What to do? Recently, I found a question from one Redditor saying that he read a book telling him to “find an edge – a discrepancy between theoretical value (model) and price,” then “enter a position and leave when the edge is gone.” And then you have Greeks, which to follow? How to use them? How do we calculate them?

 

Can you see what is wrong with it?

 

Everything! None of it matters. It is all useless. The Redditor who asked the question was approaching options with the wrong mindset. Remember this: never, ever approach options as if they were stocks. Options are not an equity; they are not anything tangible you own, and they have no value to buy. They do not represent the business or capital. They are just a contract. Dream. They are dreams and promises. One dude says, “I have something, and I will sell it to you if you are interested. If XYZ happens in the future, what deal? oh, by the way, if I hold this deal for you, you will pay me a small fee, agreed?” That is an option. Just a deal. A contract that people can buy or sell.

So, if options are just a dream, what do you do with dreams? What do you do with dreams and promises? Remember, you sell dreams to people. You do not want to be the sucker buying dreams. You sell dreams. And that is your edge.

I have seen this again and again out there. People buying options then brag about thousands of percent of the profit they made and then boom, they blow their entire account in a few months. Just go to Wallstreetbets on Reddit. That subreddit is full of suckers buying options. They all think options are like a stock. They buy it and then expect the price to go up so they can sell and grab the huge profit… But the option doesn’t do what they expected, and they lose everything. They then learn about Greeks, predictions, edges, and magical prophecies and wonder how they can use them to their advantage.

 
Here is how you start trading options.

 

1. Always sell options

 

That’s it. Do not argue with it. You never buy options, only sell them. You buy options only as a hedge, protection, or a part of a complex option strategy but never as an income-producing vehicle.

 

2. Use options as a tool to buy or sell a stock

 

Although you do not have to use options to sell or buy a stock, you still want to look at them as if you wanted it. Remember, options are just a contract. You do not sell an option for the sake of the option itself but as if you wanted to buy the stock (or sell it). This has huge implications for everything else. So even if you are not interested in owning or selling the stock, remember, you are entering into a contract that says so.

 

3. Have enough capital to trade options

 

As I said above, selling options is a contract promising or accepting conditions of the contract, and therefore, you need to have resources to fulfill the contract’s obligations. If you do not have the resources, you will get burned. Burned. It is like going to buy a house or car, signing a bill of sale, and then realizing you do not have money. It will be considered a fraud. In many states, you will probably prosecuted or sued by the other party. With options, there will be no legal consequences except wiping out your account and ending up owning money to yourself, your family, and maybe even to the broker (if you screw up).

So, when selling options, make sure you have enough capital to meet your obligations should they occur. If you are selling puts, have enough money to buy the stock. If you are selling a call, make sure you own the stock. Once you become an experienced trader, you can start trading “naked” (without enough capital or underlying stock), but as a novice, forget going naked (if you have the urge to sell naked, feel free to undress in front of your computer and trade nude, but forget about it when trading options).

 

4. Trade options against stock you are OK to own

 

You can trade high flying stocks once you are experienced but if you are just starting you want to trade slowly and you want stocks that will not burn you the first day of your trading. It is great (and it feels great) to trade Tesla (TSLA) but that stock can turn around on a dime and it can wipe you out. Pick stocks that provide decent premium and if the stock goes against you, and you will be required to buy 100 shares of the stock, you will be OK with it. Rememeber, you are selling a contract and as a seller, you will have obligations. And if you sell puts, your obligation will be to buy 100 shares of the stock; if you sell calls, your obligation will be to sell your stock. If you trade a contract against a stock you never wanted to own, or do not have money to own it, DON’T!!

The best way to start is to pick a stock you like (I personally love using dividend stocks for this purpose) and sell a put against it. If the trade goes against you, you buy 100 shares and you are OK with it. You hold the stock and sell calls. This is a wheel strategy. It is easy and simple and it gives you confidence in trading options. After “wheeling” your stock, you gain enough experience and confidence to trade other stocks.

 

5. Don’t be greedy!

 

This is important. Never sell options for the sake of the premiums you can collect. This the same mistake people make with investing in dividend stocks. They buy dividend stocks because of the huge dividend yield but then they get burned badly when the company cuts the dividend or the stock price goes down like a rock. Options can do the same thing to you. Do not go after huge premiums. I know it feels good to be collecting $200, $300, or even $1000 in premiums every week or every day. I know the feeling. I am guilty of this myself.

But, this also depends on whether you actually want to buy (or sell) the stock. If you want to buy the stock, then go closer to the money (see later) and collect a larger premium, but if you are interested in generating income, then don’t do it. Go as far away as possible.

 

Ok, here is a sample of trading options:

 

Before I show you my selection process, here is a summary of the above notes:
 

• always sell options
• alway use options as a tool (contract) to buy or sell stocks
• always trade against stocks that you are OK to buy or sell
• always have enough capital or underlying stock (wheel it)
• don’t be greedy

 

Pick a stock

 

Create a list of stocks you want to trade. Choose stocks that are in the range of $30 – $100 a share. Pick stocks you are OK to own. Use dividend stocks in case you end up buying them and sitting on them for some time. During that time, they will pay you dividends. Once you have the list, go through them and start looking for premiums and buying power requirements.

Here is my list for stocks I want to use for trading “crumb puts“:

 

 

These are a bit expensive stocks, so at the beginning you may choose cheaper stocks. The next column shows my desired strikes for “Crumb” trading. The last column shows an approximate buying power needed to sell the put option against that stock. This is a buying power in a margin account. In the cash account, you will need the entire amount equal to 100 shares (remember, you are selling a contract promising that you would purchase 100 shares of the stock).

But even if you have the stock, it still may not be the right one:

 

 

So if you want generating income, you want to go far away from the money. I strive to select a strike that is 20% (or near it) below the current price. The trade below has a 96% probability of profit. How likely will this stock fall 20% in 37 days? Although it may happen during panic selling, it still is not going to happen in one day, so you will have time to get out before it happens. If you want to buy 100 shares of AMZN, you can go closer to the current price.

 

 

But as I said before, this stock has a relatively large buying power requirements, that means, you have to have that money to sell the put. But you also need to have more money than that. If the stock starts slipping lower, the buying power requirement will go up too (if the stock reaches your strike, the requirement can quadruple or increase five times, so instead of $1,200, you will need $4,000 or $5,000 to cover this trade). If you do not have the money, do not trade this stock.

 

 

Here is your buying power requirements and potential gain and loss:

 

 

The maximum loss can be scary, but as I mentioned, that will happen only if the stock goes to zero. It is the same as if you bought 100 shares of Amazon (AMZN) at $146 a share (spent $14,600 total capital) and the stock dropped to zero. Your loss will be $14,600 a share. With this trade example, you would be buying 100 shares of AMZN at $125 a share, so your loss would be $12,500 (minus the premium) if the stock goes to zero. So, risk-wise, it is the same no matter if you buy a stock and it goers to zero or sell a put and the stock goes to zero (unless you manage to buy it back before it goes to zero).

With this options trading, I do not need to know anything about Greeks, edges, biases, technical analysis, predictions, or anything. All I need to know is my probability of this trade and trade it again and again. And with this trade, my probability of profit is 96%. The buyer’s probability of this exact trade is just 4%.

I was not trading like this before because I was greedy. I didn’t consider $26 premium large enough to bother. So I went closer to the money, collected $300+ in premiums and got burned. The stock dropped and I kept carrying around a busted trade tieng money in a helpless trade.

Today, I look at it from a different perspective. I consider the premium I collect to be a dividend. If I manage to collect $26 premium every month, that will be $78 in premium every quarter, or $312 annual income. That is as if Amazon was paying me $3.12 annual dividend. That is 2.13% yield. Not bad for a stock that doesn’t pay dividends.

To get this income, I only need to use about $1,200 of my capital without buying 100 shares of the stock. So my yield is technically 26%… And with 94% probability of collecting this money every month without worrying about assignments, I will take it every time.
 

Trading options can be intimidating and it may appear complicated and overwhelming, but it is actually very simple and easy. Just try it in a paper account first, using the rules above, and once you know the ropes, start using your real money. Create your money making machine.