Paper trading using one of the many virtual trading systems provided by option brokers, and now CBOE, is so important if you have never traded options. This is especially important trading credit spreads, like Bull Puts and Bear Calls and ultimately Iron Condors. These are special strategy trades that must that must be fully understood before trading with your own funds. You must practice entering, closing and adjusting Bull Put and Bear Call spread trades. You must fully understand an Iron Condor trade and the requirements for making sure your broker only applies margin to one side of this 4 legged trade. And most important you must practice closing these spreads and rolling to new spreads when trades go against you.
I paper traded for six months using OptionsXpress’s virtual trading system before using my own funds. This is the system now used by CBOE so new traders no longer need to apply for a brokerage account to paper trade using a virtual account.
To get started you should establish a virtual trading account with your broker or just use CBOE’s free system. You must practice all types of credit spread trades like:
- Entering new trades using the current bid.
- Entering new trades using limits that are higher than the bids, like ½ of the bid/ask or midpoint. Then shave 5-10 cents off this midpoint.
- Enter stop loss orders to close profitable spread trades for 10 cents or less freeing up margin for new trades.
- Practice adjusting Bull Put and Bear Call credit spreads. You should close and roll to new credit spread trades to collect another credit. This is the most important one to practice and master before committing your own funds.
The 4 types of trades above should be practiced many times over for a period of 2 to 3 months. Never enter into one of these specialty options trades using your own funds until you completely understand all the risks. You must have an exit plan and know exactly what to do when a trade goes against you.
Once of the huge advantages you have with option spreads is that you can breakeven when a spread trade has to be closed. This is accomplished by adjusting, or rolling, to a new spread trade to collect a new credit. Sometimes this new credit offsets, or exceeds, the debit you incurred closing your original spread. This is a key risk management procedure that you can master paper trading. Once you complete a few of these rolling trades you will really get excited about trading credit spreads and be able to protect your monthly cash flow so that you are always adding net credits to your account.
New subscribers to my advisory service can request Flash Movie files that illustrate how each of the 4 types of trades are processed at different brokers.
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