by Amanda Harvey
Options mistakes can make the potentially rewarding experience of trading options a minefield, unless you are aware of what these mistakes are and how to avoid them. While it is possible, even for experienced traders to make options mistakes, especially if they allow their emotions to overrule their logic, it is newer traders in particular that need to educate themselves on the pitfalls to keep away from when trading options.
This article discusses some of the most common options mistakes and solutions that can be implemented in avoiding them.
1. Buying Out-of-the-Money Options
Options that are termed out-of-the-money are options that, if exercised immediately, would be worthless. This is because these options’ strike prices have not been reached by the price of the underlying asset; upward in the case of a call and downward in the case of a put option. Options with strike prices that are a great deal above or below the price of the asset are termed far-out-of-the-money. The reason that many traders are tempted to invest in these options is that they are cheap. However, they are cheap for a good reason. There is very little chance that the asset price will move sufficiently before expiration of the option contract to allow the option to become in-the-money.
The solution to this mistake is obviously to select options on stocks that are in- or near-the-money, and/or have a longer time until expiration in order to allow a far better chance of realizing a profit.
2. Buying Options too Close to Expiration
This mistake is usually made for the same reasons as mistake #1. Options that are very close to their expiration date, otherwise known as short-term options, are usually priced lower than their long-term counterparts. Gambling on the chance that this type of option can make money in a sufficiently short time is setting the trader up for far more losses than gains.
Once again, make realistic assessments of how much time is likely to be needed for an option to become profitable, and avoid making ‘bargain’ purchases.
3. Allowing Emotions to Override Logic
This is a mistake that all traders can be vulnerable to, and usually relates to emotions such as fear and greed. Fear may prompt a trader to pull out of a trade too early, rather than giving the trade sufficient time to stabilize, while staying too long in a trade and subsequently suffering a loss can be a mistake triggered by greed.
The best solution to this problem is to have a clear and precise exit plan that has been made based on logic, and to stick to this plan in disciplined determination. Yes, there is a chance that you may sometimes have made a bigger profit or a smaller loss if you went against your plan, but this is likely to be an anomaly rather than the rule. The best results are consistently attained by traders who make realistic plans and follow them.
4. Lacking Patience
It can be very difficult for many traders to wait for a genuine opportunity to make a successful trade. Wanting to be in on the action can prompt a trader to enter a position that they have reservations about, simply because they don’t want to sit on the sidelines.
Developing patience, while it may be easier said than done, is the only solution to avoid jumping into trades that do not have solid potential for gain. Truly restless individuals could consider paper trading as a way of keeping themselves active and involved while they wait for the trades with true potential to appear.
Avoiding the options mistakes covered in this article can make the difference between a successful trading experience, and becoming a casualty of the options trading arena. The basis for implementing the solutions offered is in understanding what the pitfalls are, and in developing a logic-based, practical and disciplined approach to trading options.