When trading options, we should make sure we use our due diligence in our analysis. We should consider the fundamentals of the underlying stock, the sector or industry of the underlying stock, and what the charts of the stock are showing us.
There are a few other considerations we might want to make. Due to the leverage of options, option prices can be quite volatile. For the most part, it would be wise to go with the flow of the overall market. If the market is bullish, making put trades can be very risky and if the stock does drop, the returns might not be very rewarding.
When looking at the overall market, consider checking the volatility index ($VIX.) Remember this is a contrarian indicator. A saying that goes along with the $VIX is “When the VIX is high, it is time to buy. When the VIX is low, it is time to go.” The high and low will be like a support or resistance. After it peaks and heads down is high. After it bottoms and heads back up is low.
Look for option contracts that have high open interest –preferably in the thousands, but minimum of 100. Also look for contracts that have narrow spreads. Typically the monthly options and the strike prices that end in 5 or 0 have the greater activity which results in narrower spreads.
Consider using market orders if the spread is narrow. Sometimes in an effort to save a few bucks, we end up losing more money by doing limit orders, especially in a fast moving market.
One thing I forgot to mention in the grad call is that we should check the implied volatility of the stock. If implied volatility is climbing, we better find out what is occurring in the news for the stock. Higher implied volatility means higher option prices. Knowing when and what the news could do to the stock price is a critical piece of options trading.
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