Avoid Some of the Most Common Option Trading Mistakes
Buying out-of-the-money (OTM) call options” Option Mistake
Most traders are used to buying low and selling high, that’s why they may buy OTM’s, but buying OTM calls is one of the hardest ways to make money consistently when it comes to option trading.
If you limit yourself to only this strategy, you can find yourself losing money consistently and not learning very much in the process. Consider learning and educating yourself with your options trading. Learning a other techniques and strategies and improve your potential to earn solid returns as you build your knowledge.
What’s wrong with just buying calls? Trading Against a Clock is not an Edge: Mistakes
Calling the direction of a stock is hard enough. When you buy options, however, not only do you have to be right about the direction of the move, but you also have to be right about the timing. There is a reason why OTM’s are cheap. Ever watch an ice cube sitting in the afternoon sun? That’s what the time decay is doing to your money as well.
How can you trade with better knowledge? Covered Calls.
You may want to consider selling an OTM call on a stock that you already own. This strategy is known as a “covered call”. By selling the call, you take on the obligation to sell your stock at the strike price stated in the option. If the strike price is higher than the stock’s current market price, all you’re saying is: if the stock goes up to the strike price, it’s okay if the call buyer takes, or “calls”, that stock away from you.
For taking on this agreement, you earn cash from the sale of your OTM call. This strategy can generate income on stocks when you’re bullish, but you wouldn’t mind selling the stock early if the price has gone up either.
The the risk does not come from selling the option. The risk is in owning the stock – and that risk can be substantial. The maximum potential loss is the cost basis of the stock less the premium received for the call plus commissions.
Using “The Same” strategy in all market conditions: Mistakes
Option trading is flexible. It can enable you to trade effectively in all kinds of market conditions. But you can only take advantage of this flexibility if you stay open to learning and adjust accordingly.
Buying spreads offers a way to make money in different market conditions. When you buy a spread it is also known as a “long spread” position. New options traders should familiarize themselves with the possibilities of trading spreads.
How can you trade more informed?
Here’s a popular rule-of-thumb: If you are trading options, make sure the open interest is at least equal to 50 times the number of contacts you want to trade. For example, to trade a 10-lot your acceptable liquidity should be 10 x 50, or an open interest of at least 500 contracts. (“Open interest” is the number of outstanding option contracts of a particular strike price and expiration date that have been bought or sold to open a position. Open interest is calculated at the end of each business day.
Trade liquid options. There are plenty of liquid opportunities each day.
Waiting too long to buy back your shorts: Mistakes
Always be ready and willing to buy back short options early.
Traders often wait too long to buy back the options they’ve sold. There are many reasons why but mainly they are excuses and not part of a strategy.
If your short option gets way out-of-the-money you may want to buy it back to take the risk off the table with some profit. Why not do it?
For example, what if you sold a $1.00 option and it’s now worth 20 cents? You wouldn’t sell a 20-cent option to begin with, because it just wouldn’t be worth it. Similarly, you shouldn’t think it’s worth it to squeeze the last few cents out of this trade.
Once again, learn your craft before you put down real money into the markets. This is serious business with serious traders out there. If you are not willing to invest in education then you are simply making a huge “Option Trading Mistake” and will not succeed.
Don’t be cheap, education cost $$$ but it is worth it.