Option Investor
Educational Article

Strategy Selection

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A few weeks ago, we began a review of option pricing concepts. Throughout this series or articles, readers learned how time, volatility, and the price of the underlying issue, as well as some less prominent factors, affect the value of an option. Today well put some of that knowledge into practice with an examination of the different options strategies traders can use to take advantage of specific market trends.

There are many types of traders and no single method or tactic will work for all of them. The vast range of objectives, styles, experience levels, and available capital makes this outcome impossible. Although the financial markets provide a virtually limitless number of profitable opportunities, you will not be a successful trader until you can:

1) Determine which prospects are suitable for your specific situation
2) Identify and correctly apply the appropriate strategy
3) Manage the position effectively

The first step in this process involves determining why you want to trade. Many people who buy and sell options have no clearly defined reason for participating in the derivatives market. As a result, they choose inappropriate strategies or they initiate trades in an inopportune manner, when it is counterproductive to their true interests. The next step is position selection and it involves two phases. These include: identifying a trade that will benefit from some type of future activity or trend in the underlying instrument; and verifying that the position is suitable for your portfolio, based on individual criteria such as risk-reward attitude, complexity, and financial condition. The final requirement for success is effective position management. Regardless of the strategy being employed, a trader will never achieve consistent, long-term profits without initiating timely exit and adjustment transactions.

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