As a trader, you know that when you trade options, you can profit whether stocks go down, up, or sideways. This sounds great but the catch here is that you can lose more money than what you have invested in a short period when trading options.
Of course, the same thing will not happen when you buy stocks outright. When trading options, you are liable to lose your initial investment or even more.
In this article, you are going to learn how to avoid costly mistakes when trading options.
1. Misunderstanding Leverage
Most beginner investors misappropriate the leverage factor that comes with their option contract without considering how much they are risking. Usually, traders will be drawn into purchasing short-term calls and this leads to the question: Is the outright purchasing of calls a “conservative” or “speculative” strategy?
A general rule for new option traders is to stick with a single option to start if you typically trade 100 share lots. This offers a good test amount, to begin with.
If you do not succeed with such a small size, there is a higher chance that you will not succeed with bigger size trades either.
2. Not Having an Exit Plan
It is important to control your emotions when trading options just as it is when trading stocks. Of course, this does not mean sweeping your fears under the rug. Rather, it is about making a plan and sticking to it.
This also means having an exit plan in place regardless of how well things are going for you. Make a downside exit point as well as an upside exit point along with your timeframes for each in advance.
With an exit plan, you get to establish successful trading patterns so that your worries can take a back seat.
Establish an upside exit plan as well as what you can tolerate in the worst-case scenario. When you attain upsides, you want to clear your position and enjoy your profits. Keep greed away.
On the other hand, if you reach your downside stop-loss, you want to clear your position as well. The last thing you want is to expose yourself to more risk hoping that price options must be restored.
From time to time, the temptation to go against this will be strong but you need to be steadfast and disciplined enough not to do it. Many traders come up with plans and as soon as they place trades, they forget their strategies and start following their emotions.
3. Being Stagnant when it Comes to New Strategies.
Most option traders say that they would never sell-in-the-money or buy-out-of-the-money options and this may sound silly until you get a trade that moves against you.
Any seasoned trader has faced this scenario and when it happens to you, you will find yourself tempted to break many personal rules.
If your plan is not working, you don’t have to continue suffering losses because of it. Instead, you want to open yourself up to trying new strategies that may turn out to be beneficial.
4. Failure to Consider Upcoming Events
Granted, there are always events in the market, but not all of them are foreseeable. However, you need to keep track of two crucial events when trading options, and these are the dividend and earning dates for your original stock.
For instance, if there is an approaching dividend after you have sold calls, chances are that you will be assigned early especially if the trading option is already in-the-money and the dividend is anticipated to be huge.
Keep in mind that option owners have no rights over dividends so to collect, you are required to purchase the underlying stock and exercise the option.
5. Having no Plan for your Assignment
Keep in mind that there is a possibility you can be assigned early before your options expiry date. Most new option traders rarely think of assignment as something that could happen to them until it does.
Of course, you will have a harder time if you haven’t thought about this and what you would do in case it happens. It would be extremely beneficial to have a plan in place in case you get an early assignment.
Options trading can be difficult, but that is only a mindset for weak traders who have poor planning skills. Avoid the aforementioned mistakes and you can be sure that your chances of succeeding when it comes to trading options are high.