By Sean Hyman Back in the day, when I first started playing options, I thought that all you had to do was “call the right direction” and you would make money on your options trade.

At the time, I was already a successful stock trader, and I just assumed I would add some leverage and quickly become a successful options trader. Easy right?

Boy was I in for a rude awakening. On my first options trade, I called the right direction and I actually LOST MONEY on the trade!

Now, how in the world can that happen?

Well, here’s how. There are actually several dynamics to an options trade and only one of those factors is “calling the right direction.”

Here’s the good news: There are couple easy steps you can take to cross the bridge to successful option trading…including learning how to call the right direction on trades.

Once you do, you can invest in not just stock, but currency options. And if you’re not interested in Forex trading…currency options trading is the next best choice for grabbing those double- or triple-digit gains off the foreign currency market.

And get this: Currency options have a longer investment timeframe. This means you can grab 200 or 300% off single currency trades…while only placing two or three currency trades in a single quarter if you wish.

But I’m getting ahead of myself. Let’s get back to the nuts and bolts of option trading so you can try it out for yourself…

There Are Several Pieces to the “Options Puzzle!”

Let’s start at the beginning. When you buy an option, you’re buying the right to either buy or sell a specific stock or currency at a specified price. To simplify things, let’s just focus on currency options for a moment.

So let’s say you buy a currency option on the British pound. You believe the British pound will rise in value over the next few months, so you buy a September call option (call just means “buy”) on the British pound.

What you’re really buying here is the time for the British pound to rise. You believe the British pound will rally soon, so you buy an options contract that expires in September. This contract gives you the right to buy the British pound at a specified price (known as the “strike price”).

This option will expire in September, but well before then, you want your option to rise in price above your strike price so you make money on the trade.

But here’s the thing: JUST because the British pound rallies doesn’t necessarily guarantee you’ll have a homerun trade here. Other factors are just as important including…

1. Time - You must call the direction right on your options trade in the right span of time or your option value will erode away even though the trade is going in your direction. It’s called time erosion.

You see, an option contract erodes away very slowly at first. The loss of value is almost unnoticeable at first. Once you start getting even remotely close to the expiration date, the option’s value starts dropping like a rock.

Why? Because it’s harder to resell that option back into the market. As your expiration date gets closer, traders have less and less time to sell the option for more than its strike price, so there’s less buying going on in the contract. In other words, fewer traders want your option as it reaches its expiration, so it’s worthless.

A Time-Sensitive Quick Fix

Options market makers have sophisticated computer models to help them to price a contract to factor this time erosion problem into their trades. But of course, as an individual trader, you don’t have such perks. So how do you remedy this?

First of all, give yourself plenty of time on any options contract. Buy your call options (or put options, aka “sell” or “short-sale” options) far out in time. In other words, don’t buy a contract that expires in 30-60 days.

Oh sure, contracts are cheap when they’re about to expire. However, they’re cheap for a reason. It does NOT mean they’re bargains! If so, the smart money (i.e., hedge fund managers and big institutions) would be bidding those options higher and they wouldn’t be cheap any longer.

However, the pros know that time erosion can work against you so fast when a contract is 30-60 days from expiring. That’s why they work furiously to avoid these long-in-the-tooth options. In fact, they’ll sell their contracts even if their option has been heading in the right direction the entire time they’ve owned it!

To remedy that, you should buy a contract that is at least a few months out from expiring on you. Some even go so far as to buy contracts even further out in time just to counteract the erosion effect as much as possible.

These contracts get more expensive, the more you go out in time…but they’re also more likely to work out in your favor too. In the end, that’s what matters.

I’ll be back tomorrow with another trick to use in your currency options trading. Until then!

Happy Trading!
Sean Hyman