Options trading can be very profitable, whether a stock goes up, down, or even sideways. Unfortunately, you can also end up losing more than what you invested quickly if you do not practice caution.
Here are some of the top ten mistakes that traders have made so that you don’t repeat these costly wrong turns.
1. Misunderstanding leverage. A major benefit of trading options is that they can be a leverage tool. Through investing in options, you can control a larger number of shares for the same initial investment, than if you purchased the shares themselves. A good general rule for trading options is that if you trade 100 share lots, you should do one option to start with. If you trade 300 hare lots, then maybe do 3 contracts. If you do not have success here, there is a chance you will not have success with bigger trades.
2. Not having an exit plan. It’s imperative to control your emotions in trading and it’s even more important to have a plan and stick to it. Choosing an upside exit point as well as a downside exit point, and your time frames from each exit, can help you make money or minimize losses. If you are buying or selling options, an exit plan is crucial. It helps you establish more successful patterns of trading. Do not allow your emotions to tempt you away from these plans.
3. Not being open to other strategies. Saying you will never do anything different can bite you in the behind. This is because you may one day find your trade going against you and by not wanting to try another strategy. Options are derivatives which means their prices do not move the same way as the underlying stock does. You have to ask yourself during the trade, would I have done this move when I first opened the position? If the answer is no, do not do it. Sometimes it’s okay to take a small loss if no strategy looks attractive.
4. Trading Illiquid Options. It’s crucial to follow trades that have liquid. This means they are moving and there is always an active buy or active seller. Having liquidity means the next trade is more likely to be executed at a price equal to the one before it. Liquidity is about how fast a trader can buy or sell something without causing a significant price movement.
5. Buying back shorted options too late. Often times traders will wait too long to buy back the options that they have sold. The reasons for this can range. One trader may not want to pay the commission while the other is betting the contract will expire and be worthless. It’s always better to buy back short options early however. If you are able to keep 80% or more of your initial gain from the sale of the option, you should consider buying it back.