Education: The Top Mistakes Options Traders MakeNovember 26, 2018
Like most investors, one of your top goals has been to enjoy financial freedom at whatever age you choose. So, it stands to reason that your money should ideally generate above-market returns with below market risk.
Truth is — if you really want to become a better investor then you need to be looking at where the smart money is heading. You need to understand what is truly driving the markets and how you can take advantage of these moves as – and before – they hit the mainstream.
That’s how the long-term wealth can be found.
However, as you start your journey, there mistakes to avoid, especially if you trade stocks, ETFs, and indexes with options.
Mistake No. 1 — Trading without a Strategy
One of the first steps in avoiding common trading mistakes is to have a trading plan.
- Do you know how much you’re willing to trade and potentially lose on a single trade?
- Do you know when to enter a trade?
- Do you know when to exit a trade?
Without answers to those questions, you should not move forward.
Or, let’s say you do have an entry plan, do you have an exit plan? What if your initial plan doesn’t work out as hoped. Then what?
For example, let’s say I bought the Apple (AAPL) December 21, 2018 200 calls in mid-October 2018 on the idea that the stock was oversold and ready to bounce. Without an exit plan, which can include a stop loss, I would be looking at an 80% loss in a month’s time.
Don’t be an irrational trader. Plan ahead.
Having a plan can help you sleep better. Trust me. Remember, you’re not trading to hit the jackpot. However, to make consistent money, you need to have a consistent plan.
Mistake No. 2 – Ignoring the Expiration Date
Among the many choices in options trading, the expiration date is a major factor.
Once you’ve figured out which way a stock may go, you have to ask yourself, “How long will it take for the stock in question to reach my target price?”
Perhaps you’re anticipating that an earnings report will have a big impact on the stock, and your option. Or, perhaps you know of a significant catalyst. Such factors play a major role. And most times, they’ll help guide you to the right expiration date.
However, if you don’t pay attention to the dates, you could wind up with an option that expires before the anticipated catalyst.
Mistake No. 3—Buying Options because they Appear Cheap
Cheap isn’t always a good thing when it comes to trading options. In fact, oftentimes, the cheaper options are those referred to as “out of the money.” And while it may appear to be a steal, if it doesn’t change to “in the money,” your chances of making money are “out the door.”
If you bought an “out the money” call option for example, you would need a considerable upward move in the stock to make any money from the call option.
For example, let’s say I wanted to make money using an Apple (AAPL) December 21, 2018 200 call option at $2.35. For me to make any real money on this trade, I need the AAPL stock to recover well above $14 a share to make any real money from this call option.
That’s not to say “out of the money” options don’t work, it’s just not a great strategy.
These are just three of the top ones we see most often.
Mistakes happen. Don’t beat yourself up about it.
Understand what may or may not have happened, pick yourself up, and try not to repeat the same mistakes. We’re only human. We make mistakes.
If you’re new to options, consider paper trading first to get the hang of it. This way, you know what to expect. Even seasoned options pros make mistakes and lose.