Option trading is a way for savvy investors to leverage assets and control some of the risks associated with playing the market. With options, it’s possible to profit whether stocks or going up, down, or sideways. You can use options to cut losses, protect gains, and control large chunks of stock with a relatively small cash outlay.
When starting out as an option trader, proceed with caution. Even confident traders can misjudge an opportunity and lose money. Do your research and begin with simple strategies.
We’ve assembled brief overviews of the 10 most common errors in option trading. Take a moment to review them, so you can avoid taking a costly wrong turn.
Mistake #1: Buying out-of-the-money (OTM) call options
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.
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Mistake #2: Using an all-purpose strategy in different market conditions
Depending on the market, you’ll want to tailor your options trading strategies. Trading the long spread is a tried-and-true approach that you should understand.
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Mistake #3: Not having a definite exit plan prior to expiration
Even when an option trade is going your way, it’s crucial to have an exit plan in advance. Otherwise, how will you make the right move at the right time?
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Mistake #4: Making up for past losses with risky doubling up
When a trade moves against you, it’s tempting to ignore your tolerance for risk and make a rash decision. Don’t. Instead, try another approach to mitigating your losses.
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Mistake #5: Trading illiquid options
The biggest drawback to this strategy is that, if you initiate or adjust an option position that’s associated with low activity, you run the risk of losing money due to poor pricing.
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Options Trading Mistake #6: Waiting too long to buy back your short options
Don’t wait until it’s too late to make your move, and don’t think that squeezing every last penny out of a trade is worthwhile. Do the right thing.
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Options Trading Mistake #7: Failing to factor earnings and dividend date into your strategy
Avoiding trades with pending dividends is a commonsense approach to investing in options. Understand how the trading season impacts stock volatility and can inflate option prices.
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Options Trading Mistake #8: Not knowing what to do if you’re assigned early
From the beginning, keep early assignment 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.
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Options Trading Mistake #9: Failing to use index options for neutral trades
Trading neutral on big indices may not sound exciting but this approach can shield you from costly market volatility.
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Options Trading Mistake #10: Legging 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!
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Comment on this article
Comments
MUHAMMAD N. on March 13, 2018 at 9:14am
IS EDUCATIVE
Portela on May 10, 2018 at 8:26am
"Trading OTM calls is one of the most difficult ways to make money consistently" Really? Who cares about making money consistently. I bought OTMs (puts and calls) for the past 8 years in Brazilian market. In one of the assets I made 92 operations (buying otm puts). I lost money in 88 of those. But the profit I made in the other 4 was enough to give me a return of 291% at the end of the 8 years. This is equivalent to 18.6% each year! So, tell me more about not buying OTMs.
Don on July 26, 2018 at 10:13am
I trade OTM too its hard but theres good returns if your right specially when you strangle making the market maker a lot nervous
ISHWAR C. on September 19, 2018 at 11:11am
In fact OTM option is cheaper than ATM and ITM option.most appropriate reason for preferring OTM is its cost factor.Those who know that buyers of cheaper articles have to cry time and again and the buyer of dearer article has to cry only once,never go to OTM option rather they prefer ITM and ATM .However keeping in view the cost ATM is advised. As one analyses the trend with the stages upward/downward and expects a desired level in a direction ,for immediate result ATM is best suited.Though it is less lucrative in comparison to ITM but it is best with respect to cost factor.
Donald H. on October 25, 2018 at 3:07pm
Good info for the beginner but I would like to see an example with real values as well as what the minimum dollar amount would be .
Ally on November 1, 2018 at 11:41am
Thanks for that feedback, Donald. We'll pass your request along to the team!