New options investors repeatedly make same mistakes, which can be avoided easily. Options are complex investment. Your buying and selling decision need to be right on the basis of price move direction and time. Options are less liquid than shares, so trading can involve large spreads between bids & ask prices. This can increase your costs.
In the end, option value is comprised of several variables like underlying stock price, volatility, dividends, fluctuating interest rates as well as supply & demand aspect.
New trader’s needs to learn options trading properly, so they can control their risks and rewards (based on their predictions). It does not matter, if they predict neutral, bearish or bullish condition, there is a profitable option strategy for their correct outlook.
Common errors to avoid in options trading
Error 1 – Start buying OTM call options
Buying call is safe because the pattern is similar to stock trading. It means buy low and sell high. Majority of veteran equity traders started in this way and learned.
In options worlds, actually buying OTM calls in the start is a hard way to earn profit consistently. You need to be accurate about move direction and timing. If you are wrong about any one, you lose the paid options premium. Besides losing money consistently, you may not be able to learn much. Therefore, educate yourself with some strategy called ‘covered calls’. Instead of buying calls, sell covered calls. This strategy is less-risky and you get an opportunity to know the options market dynamics in a better way.
Error 2 – No exit plan sketched before expiration
Emotional control is crucial in options trading just like stocks. You need to prepare a workable plan and stick to it. An exit plan does not mean just minimizing your loss on downside but you must even have one for upside. Therefore select a downside and upside exit point along with timeframes for each, in advance. Many traders, whose emotions dominated their exit plans have regretted.
Error 3 – ‘Doubling up’ to regain past losses
In adverse scenarios, option traders even the veteran ones get tempted to break personal rules and keep on trading that same option. For example, in stock trade share bought at $90 is liked even when prices fall to $60 because buying more at low prices helps to lower the trades net cost. However, for options trade ‘Doubling up’ concept does not work. Options are derivatives.
Their prices do not move in the same way and you will have to consider time decay in your plan. When things change step back and find another sensible opportunity. True, options provide leverage on very low capital, which gets blown quickly, as you dig deeper. Therefore bear small losses, whenever offered to avoid catastrophe later.
Error 5 – Waiting long to buy short options back
Traders often wait long to purchase the sold options because they don’t desire to pay commission or you feel the options contract will expire valueless or you hope to earn more profit from that trade.
It is advised to willingly purchase short options back early or else they may gnaw your earnings.