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Best Practices

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4 Boxes to Check Before Entry

Best Practices

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Tom takes traders through our checklist of what we need to see before entering a trade. The goal here, as Tom states, is to help traders form the “foundation” needed to trade options and be successful.

The most important box to check when opening a trade is that of liquidity. Tom talks about how we often do not pretend to know anything about an underlying when entering a position, but we do need to know that the liquidity is good. Without a liquid market, opening a position at a fair price and then managing or rolling can be extremely difficult.

Next, we like to check what the implied volatility (IV) level of the underlying is and what it looks like against historical IV. Tom uses IV Rank as a signal of when IV is high for a given underlying. This IV level lets a trader know when to use a particular strategy.

The current price of a given underlying also factors into a trader’s decision about what kind of trade to enter. Though we usually default to a neutral bias, trades with slight bullish and bearish biases can be implemented in order to take advantage of a potential reversal in a beat up or overbought underlying.

The last box to check is that of what strategy to implement. This decision is a culmination of the previous three parts in that traders should choose a strategy given a certain liquidity, implied volatility, and price environment.

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