31 Oct New Option Traders Need To Avoid Several Common Mistakes
Option trading is a good strategy that can be used in any kind of market environment, either to produce profit, generate income or hedge risk. When option trading is done properly, it allows investors to gain good control over their risks & rewards depending on their estimate for the considered stock.
If you are new to option trading then avoid the common mistakes given below because these can quickly erode your trading account.
Avoid Focus on Only OTM Options
Many experienced equity traders start buying call options because they are used to follow the principle of buy low and sell high. In addition, OTM is cheap. The option value you bought at will decay overtime.
Therefore, the price needs to move in either direction before expiration. Moreover, the change percentage needs to be sufficient to counterbalance the option cost.
In option world, buying out-of-the-money calls directly is a hard way to gain profit. Limiting yourself to this strategy only will make you lose money consistently. It is advised to learn few other options trading strategies and enhance your skills.
Avoid Finite Approach
Option trading is flexible, which is effective in every kind of market environment. However, all option strategies do not work in every market condition. Buying OTM put or call option, when a considered asset is barely moving will not possibly generate good results.
Alternatively, writing covered options, when underlying market remains still can generate extra income. Other complex strategies like Iron Condors can help you in such calm market conditions to produce profits. Diversifying the strategies to be used for different market scenarios and for different stocks based on their propensity can be very helpful.
Ignoring an Exit Plan
Exit plan helps to alleviate the loss on downside. Even if things are moving correctly, an exit plan is crucial. You never know, when it will be needed. Trading plan helps to establish patterns more successfully as well as minutely control your emotions.
Determining the up and down exit points helps to control risk. Temptation to violate trading plan can be strong but stick to it.
Compromise Risk Tolerance to Balance Past Losses
‘Doubling up’ to capture losses is bad in option trading. For example, you bought a stock at 70 and now you need to leave it at 40. As an equity trader, you may be tempted to purchase more, thus lower net cost based on trade.
In options, time decay for good or bad position needs to be factored in your plan. If you dig deeper, options can blow you quickly, even if it provides great probabilities to leverage on comparatively low capital.
Unaware About Market Moving Events
It is necessary to ensure, if there are any upcoming market moving events related to your specific stock within the timeframe. Announcement of earnings, for example can dig a hole in your plan through increasing volatility, fluctuating market environment and positioning your docile strategy needlessly in jeopardy. Therefore, be knowledgeable about happenings.
Major economical events causes a rapid change in market condition, so the strategy you use need to accommodate this. Monitor earnings calendar and economic calendar to create a plan on how to trade around major events.
Many opt to take a break from trading, when these events are near, thus eliminating the huge unidentified prediction of how market will respond to the event.