> At a minimum, know exactly what the worst case scenario is with each trade. Make sure this isn't more than you can lose.

This. Actually, it's not just the minimum - it is the best way, and possibly only way, in many cases.

Many traders/investors went bankrupt by assuming some statistical model of how things behave, and using this data, assumed that e.g. with 99.999% confidence, one trade's profit will be able to cover another trade's loss if things go bad. However, when things go bad, they tend to do so in ways that do not match historical patterns, and thus these models are invalid.

Also, if you are short call, long put, long underlying (in the right proportion) then theoretically you cannot lose. However, the options and underlying are likely to trade in different markets (with different rules, different margin requirements, and lacking a netting agreement), and as a result, extreme market movements may make your "perfectly hedged position" a huge loss because e.g. your underlying gets liquidated due to a margin call at the bottom of a flash crash, but your synthetic future remains; and now you're exposed.

> There are no market makers in options, so bear in mind that you can buy a lot of options and not be able to sell them later.

Where did you hear this? While it's true that not every market has market makers, there are many market makers for CBOE and MEOP options that are blessed by the exchanges.

On top of that there are many more funds that make their living solely on being option market makers. We do pretty well in the Canadian markets.

Corrected, thanks for pointing that out. I heard an anecdote of someone buying a lot of options and not being able to close the position later - I guess it happened in an illiquid market.

Yep, it's not uncommon to look at the book for an option and see huge sizes on one side and no one at all on the other side.

Could you explain this a little better? I'm sure you're not contradicting yourself, but that's how I'm understanding it.

What risk is there of not finding the other side when you are playing the options game? In your first post you seem to imply that this isn't really a risk.

Ah, I see what you mean. Yes in this case I'm contradicting my self a bit.

The thing about options, as compared to stocks, is that they can be literally worthless. A stock that is bankrupt can still have a buy side bid of a few pennies as the buyer can hope for some cash from the bankruptcy proceedings.

Consider a Call option on facebook for Nov 16th with a strike to buy at $40.

This means you can buy facebook for $40 up until Nov 16th. Currently FB US Equity is trading at $19.50, so with 2 days left and it's historic volatility there is almost no way it's going to get to $40 and make your option worth anything.

In this case the Sell side of the book would have many offers as everyone would love to sell this call for any amount of money as it's worthless.

On the buy side you'd expect no bids as there is almost no way this could make you money.

Now when I mentioned market makers I was referring to trading options that still have some value. I assumed that the OP was talking about not being able to sell options when they had some value, in this case there is always someone willing to act as a market maker in this case.

Thanks, that makes a lot of sense.

I thought there was the implication that somehow you might not be able to exercise your option due to lack of market maker.