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Replacing Traditional Options With Synthetic Options

Option trading can be very liberating for individual traders. Options offer traders the opportunity to have unlimited profit potential with limited risk. No matter who you are, small trader or money manager, if you can limit your risk up front it becomes more comfortable to take the risk. Options have the ability to provide a high level of comfort. There is simply no misunderstanding what you are getting into when you purchase an option. If you invest $400 to purchase a call or a put, your risk is limited to the $400-no more than that, but possibly less if you sell the option early. This is not the case when it comes to all investment products.

Collar at the Inception of a Trade

The collar requires three components: the initial trade, long or short; an out-of-the-money option that is purchased to lock in profits, either a call or a put; and an out-of-the-money option (which sits ahead of your initial trade) that you sell. For instance, if you have a long collar trade on the euro, you purchase a put at support, go long the market, and sell a call at some point of resistance.

Using Options As a Secondary Stop Loss

The second way to use a protective option is in conjunction with a stop. The closer an option is to its underlying asset, the more expensive it will be. It stands to reason that an option placed at a 2 percent loss threshold will be more expensive than an option placed at a 10 percent loss threshold. Whether because of account size, number of contracts placed on the trade, feeling a premium is too expensive, or simply looking for a way to stagger your trades, having a stop loss order in the first position and a protective option as a secondary stop loss can be an advantage.

Myths of Trading

There are many trading myths that affect both novice and experienced traders. Typically, these myths force traders into a narrow belief that they have to be perfect or nearly perfect in order to succeed. This myth, along with a few others, holds traders back from achieving their true mission-making profits.

Limitations of Stop Loss Order

Stop loss orders are simply a tool. There is nothing wrong with them when used properly and with the proper expectations. When a trader works within the confines of the ability of a stop, then the frustration of stop orders can be diminished. The simple fact is that when you know what to expect you can’t be disappointed.

Drawbacks Of Synthetic Option

No matter how great the benefits are, when it comes to trading synthetic options there are still some drawbacks. The first drawback is the fact that it is capital intensive. The option must be purchased up front and the margin or cash for the position must be put in place. This means that you essentially have two trading positions at the same time.

Synthetic Option Versus Standard Option

Synthetic options come in one of two flavors, synthetic calls or synthetic puts. They each are designed to simulate a standard call or put option without the drawbacks. A synthetic call is simple to initiate. A long position is first established in a spot forex market, futures market, or stock market; then an at-the-money put is purchased to protect the long position against any downside risk. A synthetic put requires that a short position be initiated first and an at-the-money call is purchased to protect the short position from any sudden moves to the long side. They are one of the most underused risk management tools available.

Five Core Components of a Trade Setup

Now you have become more flexible in your trading. You no longer define yourself in such rigid terms as day, swing, or position trader. You have become more of a market specialist. You have found the few markets that you want to trade and you now find yourself open minded to the daisy chain effect that bears on the markets you watch. Are you ready to get started yet? Not quite.

Steps for Money Management in Trading

Money management is simply how you treat the capital that you use when you are trading. It is meant to be a guideline for what you will do regardless of whether your money sits idle, you are in a winning trade, or you are in a losing trade.

Set Up Your Test Account

While demo trading and paper trading have a place, the best thing you can do for yourself is to set up a test account. Don’t bet the whole farm, simply a portion of it to get a feel if trading is for you. The reality is that trading futures and forex is not for everyone. The majority of them would be better off having someone managing their investment portfolio.

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