Trading options can be one of the most effective tools for investors to leverage their existing assets and control their overall portfolio risk. Options allow investors to profit in up, down and sideways markets, which make their appeal so great.
Options can also be used to cut losses, protect gains and control large amounts of stock with a small capital outlay.
Yet, some investors jump into the deep end of the pool and don’t use common sense.
Options, unlike stock trading, have a few rules you need to follow in order to prevent destruction.
Even the most confident trader can get out of the gates too early and get crushed.
Here are 10 of the most common mistakes for both new and experienced traders.
Mistake #1: Buying Calls That Are Out of The Money (OTM)
Trading OTM calls is one of the most difficult ways to make money consistently. If you’re new to options trading, consider another strategy first.
Mistake #2: Using one strategy to fit in all markets.
You will want to tailor your options trading strategies depending on the market. Trading the long spread is a tried-and-true approach that you should understand.
Mistake #3: Having an exit plan prior to expiration
Even when an options trade is going your way, you must have an exit plan in advance. Otherwise, how will you know what move to make at the right time?
Mistake #4: Doubling up to make up for past losses.
If a trade moves against you, it’s tempting to ignore your risk tolerance and make a snap decision. Don’t. Instead, mitigate your losses and you will come out ahead.
Mistake #5: Trading options with no liquidity
The biggest downside to this strategy is if you initiate or adjust an option position that’s associated with no activity, you will inevitably run into to poor pricing.
Mistake #6: Waiting too long to buy back your short options
It is never in your best interest to wait to make your move. If you try and squeeze every last penny out of a trade you could wind up on the wrong side if the market switches.
Mistake #7: Not factoring earnings and dividend dates into your strategy
Do try and avoid trades with pending dividends. This is a commonsense approach to investing in options. Understand how the trading season impacts stock volatility and can inflate option prices.
Mistake #8: Not understanding what to do if you’re assigned early
Always keep the idea you can be assigned the shares in mind. If you think about it strategically, you won’t be caught in a bind if there’s an irrational and disruptive market event.
Mistake #9: Not using index options for neutral trades
Neutral trades on big indices may not sound exciting but this approach can shield you from costly market volatility.
Mistake #10: Learning to leg into spread trades
This is a common mistake among rookies and experienced traders hoping to squeeze the last few bucks out of a trade. Do not fall for it!
— The Option Specialist