Many beginning option traders never actually trade options. Instead, they start by "playing on paper." But this can be quite different than actually trading options. Having real money on the table changes the entire game.

The best way to gain experience is to start trading on a very small scale until you gain some skills and confidence. If you buy low-priced options you don't have to put a lot of money at risk to begin trading. The low-priced options we recommend in Ultimate Option Strategies are an excellent place to start.

In Search of a Broker

In order to trade you must open an options account with a broker. Make sure to use a discount broker. But with some discounters as well as online trading you will have to do a lot or even all of the order entering without broker assistance. If you need some assistance executing your trades you need a broker that provides some.

You won't survive the options game if you don't get a discount on commissions. If you use a full service broker ask for a big discount on commissions. Most will give you a break. But don't let your broker talk you into a "managed" options account. When it comes to options trading it is wise to heed the old poker adage of "when you have money in the pot play your own cards."

Don't Plunge

As you start trading remember that the biggest error novice players make is that they overdose and put too much money in the market at one time. Veteran traders don't make this mistake. Draw up a game plan with which you spread your purchases over several months or more. Diversify over several positions and buy both puts and calls.

Far too many traders lose patience and jump on what they think is a "slam dunk" with all their money, only to watch their options waste away and money disappear. Don't be one of them. Be patient and only play with money you can afford to lose.

The options market is open every business day of the year. If you can't place a good trade today, there's always tomorrow. If you subscribe to Ultimate Option Strategies you will receive at least three new recommendations every week, plus up to 100 additional options to play. That should be enough action for even the most aggressive speculator.

If you want to make money trading options, you must have a game plan. The "5 Ps" apply here — Proper Planning Prevents Poor Performance. Most novice options traders either lack a game plan or lack the discipline to follow their plan. As a professional options trader I have identified three keys to success when you speculate with options.

1) Identify and play only undervalued or no worse than fairly valued positions. The main key to success is to identify mispriced options and pounce on these positions.

If you are an option buyer look for undervalued options. Most option traders are momentum players and follow crowd-driven strategies such as buying options on stocks that are about to split or are in strong uptrends. But because everyone is doing this the option prices are exorbitant.

Never follow the crowd. These players are no different than gamblers in Las Vegas. Anyone can catch a winning streak, but eventually the take (commissions) and slippage (difference between bid and asked prices) will get you. The options game is a zero sum game. Half the players win and half lose. The professionals only play the game when they have an edge. Our recommendations in Ultimate Option Strategies help you also get that edge.

2) Have a well defined game plan. Even when you only select undervalued options, without a good game plan you are doomed. This is especially true for option buyers.

When you buy options you have many decisions to make. When do I take profits? When do I cut losses? How long should I stay in the position? Without a game plan you leave these decisions to your emotions. And your emotions always lead you in the wrong direction. The more quick decisions you make, the more mistakes you will make. That is why being a successful options buyer is tough.

In any option buying game plan, I decide my profit goal for half my position in advance, and at what stock price I will exit the entire position and keep my profits. And I usually don’t hold a position during its expiration month unless it has little value. You may have only one chance to take profits -- a game plan ensures that you do so when you have them. In Ultimate Option Strategies we always give you the essential information to help you formulate a game plan and then follow that plan.

3)  The discipline to follow your game plan. This final key to success separates more players from their money than any other. The pros never disobey their stop losses. Discipline is critical when you trade options. Sure, at times you may take profits too early or cut losses too early. But in the long run following your game plan will pay off and may save you from financial Armageddon.

A low-priced call option or put option can turn into a profit almost overnight. But just as important, this volatility makes it doubly important to take profits when you have them.

When we say "take profits," we mean that you should close half of your position when the option hits its target price. Then let the rest ride for possible future gains. In Ultimate Option Strategies you will never have any doubt about what the target price is. We tell you exactly with all of our recommendations.

Then, if an option you are "riding" begins to lose value, immediately close the position and take the rest of your profits. The easiest way to monitor this is with the underlying stock. If the stock reverses direction by 5%, close your position. You should also do this with options that have gains but have not hit their target prices.

Cutting Losses

 As important as riding your winners and aggressively protecting your profits is to cut your losses when you have them, too. In fact, cutting losses is more important, because when you buy options you will likely have more losers than winners.

The big hits that you get with your winners should offset your losses. But they will only do this if you keep your losses as low as possible. For some reason many, if not most investors have a hard time taking losses. But this is what separates professionals from amateurs. It also separates amateurs from their money.

A losing option position will eventually expire worthless. To keep this from happening you must take the same kind of "mechanical" trading approach to losses as you do with winners. In Ultimate Option Strategies we give you stop-loss prices with every position we recommend. If you follow them closely you will always get out of a losing position before it turns into a disaster.

The bottom line is this -- when you are involved in short-term trading, and options certainly fit that description, you must take a completely mechanical approach to your trading. Take profits when you have them, and take your losses when you have them, too. Any other approach is doomed to failure.

The key to long-term success as an options speculator is to hit home runs. And the key to hitting home runs is to buy extremely cheap options. This technique is called "bottom fishing." When you buy options for speculation I believe that bottom fishing is the best approach to follow. It is the approach we follow in Ultimate Option Strategies.

Cheap options have the potential for spectacular gains. But finding real cheap options that are underpriced and have the potential for a home run is not easy. You need tremendous patience. You may have to enter a lot of orders before you get one filled at your price. Most cheap options expire worthless, so you must have the patience, discipline and resources to keep trying for a home run.

Try to find options that are priced under 1-1/2 and the strike price is close to the stock price. Make sure the options are underpriced and have a probability of profit of at least 20%. Try to buy options on stocks that have the potential for surprise volatility. To get your best deal try to buy put options on stocks that are rallying and call options on stocks that are falling. Also, stocks tend to fall much faster than they rise, so buying put options tends to be a better bet on surprise volatility.

Where to Find Stock Option Candidates

The nature of the market today creates opportunities for surprise volatility. The market is dominated by institutional money managers, and as these managers move in and out of stocks a lot of surprise volatility develops. For example, a negative earnings report or news item might cause many institutions to sell all at once. On the upside a stock may become the target of a merger or buyout. Both of these situations can create a lot of surprise volatility.

One place to look for stocks with surprise volatility potential is in momentum industries such as technology, biotech and telecommunications stocks that are traded on the over-the-counter market. The smaller capitalizations of these types of stocks make them more volatile. Other candidates include small stocks with heavy institutional ownership, stocks that have received too much hype, stocks rumored to be takeover candidates, and foreign stocks (ADRs) in unstable countries.

When you're looking for options on momentum plays such as these, you will probably have better luck taking the "opposite side" of what the crowd is doing.

No matter what the current market conditions are it is always a good idea to be ready for a sudden pullback. In today’s market this is more important than ever. Computer-driven trading and push-button money transfers make a bear market happen almost overnight.

In this scenario most investors will be unable to get their money out in time. So it pays to have some "portfolio insurance" to guard against a market collapse. Options can be used for this. And even if the market itself doesn’t collapse individual stocks do almost every day. You can also use options to profit from these short-term moves.

In both cases you are using the same strategy. The strategy is to buy put options. A put pays off when the price of a stock declines. Buying a put option is as easy as buying a call option. And your risk is the same -- you can only lose what you pay for the option, nothing more.

The best strategy for buying portfolio insurance is to buy underpriced put options on stocks that fall further than the market during a decline. The best place to find these options is our recommendations in Ultimate Option Strategies.

You can also find ideal candidates among the 100 or so additional option plays we give Ultimate Option subscribers every week. Take advantage of this by buying one or two of these options, taking care to "time-diversify" by always owning puts that expire in every month of the year. These puts may pay off even if the market or your stocks don’t fall. So not only will you be buying portfolio insurance but you may also develop an entire new profit center.

You never know when the market might suddenly catch a bad case of the chills. And you certainly want to be in the game and ready to profit if it does.

When you buy options you are betting on "surprise volatility." In other words, you are betting that the market’s outlook and volatility for a stock will change dramatically before your option expires. 

The catch is, of course, is that you have to be right about the direction the stock will move. It won’t do you much good if you buy a call option and then watch the stock go into a sudden nosedive. 

It’s volatility may increase, but not in the direction you want it to. A way to take advantage of a volatile market or stock without being correct on the direction is to buy a "straddle." 

A straddle can be effective when you anticipate a sudden change in a stock’s price due to an impending earnings announcement or other news event that might trigger mass buying or mass selling depending on the nature of the news.

Buying a straddle is the same as buying options, except that you buy one call and one put on a stock at the same strike price and expiration month. 

The advantage of a straddle is that a properly designed one gives you a high probability of profit, better than with just buying options. When you select options to buy you are looking for options that are undervalued. 

When you select straddles the same guideline applies. But with a straddle you must go one step further — you must make sure you also have a high probability of profit. 

For example, once when Motorola (MOT) was selling at 56, and you could have bought a MOT 55 Call for 3 and a MOT 55 Put for 2, creating a straddle with a total cost of 5 points ($500).

To make a profit on the call option MOT would have to move above 60 (strike price plus the total cost of both options) before expiration. 

To make a profit on the put option MOT would have to move below 50 (strike price minus the total cost of both options) before expiration.

How could you mathematically know if a straddle was a good strategy here? You would have to use a stock simulator that tells you the chances that a stock will be above or below your price targets prior to your option expirations. 

One program that tells you this is Option Master Deluxe (for information on purchasing this software call 925-258-0960 or see our online Store.). 

In our Motorola example the simulator told us that the chances of MOT being above 60 or below 50 prior to expiration was 86%, above the "go point" of 80% that you should use when you evaluate a straddle.

A straddle has some disadvantages. 

First, your investment cost is on the high side, as you must buy two options instead of one. So your chances of hitting a home run are decreased. You don’t get the same leverage that you do when you buy cheap options.

Second, most option traders suffer from inertia. You will probably only have one opportunity to take profits with a straddle, and most traders will miss this opportunity and lose most of their purchase price.

When and how you take profits is key. 

If the stock hits one of the breakeven prices let your profits ride, but set a very close stop loss based on the underlying stock to keep from losing most of your purchase price. 

In our Motorola example, if MOT moves to 61 let the position ride, but set a mental stop at 60. If MOT falls back to 60 clear out of the entire straddle. 

If MOT moves to 63 set a stop at 61, etc. These kind of moves can be made by a stock in a single day, so you must be ready to act quickly. If you hesitate your straddle profits could easily disintegrate.

Options are excellent speculative vehicles. 

Cheap options can give you outstanding bang for your buck, or good downside insurance when you buy puts. But you can also use options as a replacement for purchasing stock, and get far more leverage and far less risk as you participate in the stock market. 

This strategy protects you from the risk of a crash in the market as long as you don`t go overboard. You can also participate in some of the momentum stocks without the huge risk and the huge investment.

To use options as surrogates for stocks you must usually purchase in-the-money calls (the stock price is above the strike price). In-the-money options are expensive. 

When dealing with more expensive stocks you will have to pay from 5 points to 10 points ($500 to $1,000) for in-the-money options that have minimal time value (premium beyond the option`s intrinsic value). The drawback to this is that if the stock has a sharp correction much of your premium will collapse. 

To protect yourself somewhat from this you can buy a LEAP, which is a long-term option that can last for up to two and a half years. This large amount of time helps the option premium hold up better during a stock decline. But a LEAP will be more expensive than a nearer-term option.

When buying expensive options it is very important to set a mental stop loss on the underlying stock, where you sell the option if the stop loss is hit. 

This will usually protect you from losing much or all of your option premium if the stock declines. This stop loss should be a "trailing stop." As the option increases in price due to a rise in the stock you keep moving the stop loss up. 

The stop loss should be set at about 15 to 20 percent below the stock price. Letting profits slip away is a major sin of option buyers.

Another approach to buying options as surrogates for stocks is to look for cheap options that are still in the money. 

Here we are looking for options that are priced under 1-5/8 ($163) and are also undervalued. 

For example, once we recommended an Eagle Hardware (EAGL) Jul 17-1/2 Call for 1-3/8, when the stock was priced at 18-3/8. The option was almost 1 point in the money, and would give you almost point for point action as the stock rose. 

And all it cost for this leverage and low downside risk was 1/2 point (option premium minus intrinsic value, or 1-3/8 - 7/8 = 1/2). As it turned out EAGL rose to 25 and the option rose to a high of 7-1/2. Instead of buying the stock and risking 18-3/8 ($1,838) to make a profit of 6-5/8 ($663), by buying the option you would have risked 1-3/8 ($138) to make a profit of 6-1/8 ($613).

So, options can be excellent surrogates for stocks. But make sure you pay a fair price for these more expensive options and use a stop loss to protect your premium in case the stock declines.

One lower-risk way to play the stock market is to buy long-term options, or LEAPs. 

A long-term options can be an excellent surrogate for the underlying stock and allows you to participate in the action of the stock for a lot less risk. 

In my research I have found that time is a key to success when you buy options. Long-term options buy you a lot of time, in some cases more than two years. 

And stocks can make gigantic moves over this time period. The major problem with LEAPs is that they are usually quite expensive. To solve this, I suggest that you use a vertical debit spread. 

A properly designed debit spread has the same limited risk as buying options. LEAP call spreads work best on volatile stocks that have been beaten down or are at the bottom of their trading ranges.

The word "spread" seems to scare some options players, but a debit spread is quite simple. 

The big advantage of a debit spread is that it reduces the cost of the long-term option you are buying. For example, I once recommended a long-term play on Applied Materials (AMAT) when it was priced at 28. We wanted to buy the AMAT Jan 35 Call at 4-3/4. To offset some of the cost of this option we also recommended selling the AMAT Jan 45 Call at 2-3/8. 

This reduced the cost of the Jan 35 Call to 2-3/8 (4-3/4 minus 2-3/8).

What did we give up by using a debit spread rather than just buying the option? 

Once AMAT crosses the 45 strike price our profit is limited. The gain in the option we bought will be offset by the price rise in the option we sold. 

Your total profit potential is the amount of the spread minus the cost of the spread. So for our AMAT spread our total profit potential is 7-5/8 (45 minus 35 equals 10, minus 2-3/8 equals 7-5/8).

But our maximum risk with this position is what we paid for the spread, 2-3/8. So our potential return is more than 300%. and we have a year for the stock to move.

Debit spreads usually don`t generate maximum profits until expiration or the stock moves deep in the money (in our example, if AMAT moves above 45). So if the spread generates a 100% gain in the first six to nine months, I would take profits. A 100% gain now is better than a possible 300% return in a year.

If the stock moves against you in a debit spread, another good tactical move is to buy back the option you initially sold if it has lost most of its value. 

Then you would own the long-term option without the profit limitations of a debit spread. 

For example, if AMAT drops from 28 to 22 and the Jan 45 Call drops from 2-3/8 to 1/2, you could buy that option back and then own the Jan 35 Call with no limit on possible gains.

Even the major stock indexes can become very volatile and unpredictable. And volatility is an option buyer’s best friend.

Usually it is a bad idea to buy index options. They’re usually overpriced, and buying overpriced options is a recipe for disaster in option buying.

Plus, indexes lack the surprise and sudden volatility that you can get with options on individual stocks. The diversity of indexes neutralizes big moves made by a few of its component stocks.

But if you like to bet on the action of the overall market, here is one way to do it. 

Conditions have to be right, and you must have the patience to wait for those conditions. Several traders we know have had great success with this tactic. 

A subscriber to one of our publications bought $3,000 worth of cheap index options and took profits after they tripled in price. That sounds good, and there is nothing wrong with taking profits, but get this: if he had hung on, he could have made as much as $100,000.

Here's What You`re Looking For: 

During expiration weeks (the week before the third Friday of the month), the market tends to be more volatile. And during the "triple witching" months of March, June, September and December, when index futures, index options and stock options all expire in the same week, volatility can increase dramatically as professional program traders unwind huge positions. 

But, the option pricing programs used by almost all professionals have a tendency to underprice options during the final days before expiration. 

This is when index options can become bargains. Look for an index option on the S&P 100 Index (OEX) or S&P 500 Index (SPX) with a strike price within 5 or 10 points of the index price and that is priced at 3/8 or less. 

Then hold on and see what happens.

Obviously, there`s more to it than just that. The keys to success with this tactic are the same as with buying options on stocks. Pay the cheapest possible price, and have the discipline and patience to wait for that price to appear. 

There will be months when you will not find a play that meets your guidelines. You also have to be able to handle a lot of losses. During many months your options will expire worthless. 

That`s why it`s important to pay as little as possible for your options, so you limit your losses and preserve your capital over a greater period of time. 

You must use only a small part of your risk capital for any one position. If you follow these guidelines, this tactic can turn into a gambler`s delight.