The typical learning curve progresses from basic to advanced. Upon grasping the elementary principles of a particular trading vehicle or strategy, individuals can then move on to more complex topics. The evolution is one from milk to meat – walking before running. It stands to reason then, that one would be better served by starting with conservative strategies at the outset. This fosters an environment where mistakes are less painful and punishment less severe. One is less likely to abandon hope when missteps are met with a mild hand slap versus a two-by-four to the face.
The stock market is setup in such a way that it’s natural for most to start slow. That is, most begin by swing or position trading without margin. The longer trade duration affords more time to think and the lack of margin provides an unleveraged environment where losses don’t accumulate as quickly. Upon mastering the basics, they may up the complexity or aggressiveness a notch by either shortening the duration (day trading perhaps) or trading on margin (upping the leverage).
Ironically, the option market is quite backwards when it comes to the learning curve. The building block nature of the options mart necessitates traders first master the basics of purchasing directional calls and puts before moving into more complex spread positions. From a risk perspective this process moves from ultra aggressive to conservative. In other words, purchasing directional calls and puts is just about the most aggressive way you can use an option. While the rewards can be quite large, the losses arise swiftly. The odds are not in the favor of the perpetual option buyer. Only the best market timers can boast consistent profits with this approach.
Sadly, many fail to realize that even though buying a directional call or put is the simplest option trade, it’s also the most aggressive. Learning how to trade options in this manner is tantamount to learning how to trade stocks by day trading on margin. The margin for error is slim, the lessons you must learn are more costly, and the emotional capital required is much higher.
After learning the basic properties of calls and puts, most traders would be well served by moving swiftly into more conservative option plays which provide a more forgiving learning environment. By reducing the speed at which losses mount, traders drastically increase their odds of survival and the likelihood they can outlast the tuition cost of lessons that must be learned.
For related posts, readers can check out:
Strategy Hopping
Step into a New Dimension
A Bet is a Bet is a Bet
{ 2 comments… read them below or add one }
Tyler,
I agree with your general thrust, but offer these suggestions:
1) Discourage beginners from buying options. Mandatory practice for all mentors/teachers
2) Stress the gargantuan importance of risk management
3) Begin with a hedging strategy:
a) Covered call writing for people who already own a stock portfolio
b) Credit or debit spreads for people who have no investing experience. They can begin with buying puts and call – but ONLY in a paper-trading account
4) I don’t have the data, but I believe this: Most DO NOT learn by becoming swing traders. Most begin life and buy and hold investors. They they discover the error of their ways and look to options as a hedge.
I use these principles for my students and none of them gets caught up in the hype that suggests that option buying is a winning methodology.
Thanks for the added thoughts Mark. I’m in agreement with you on #4. In the post I was primarily referring to those who are seeking a more active style of trading than buy and hold. I suspect there are more individuals who start with swing or position trading versus day trading.
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