When used properly, options enable investors to have better control over the rewards and risks depending upon their projections for the stock. Regardless of your forecast, there is an option strategy which can be profitable if you have a correct outlook. You will want to avoid the mistakes below that traders often make.
Starting Out by Purchasing Out-of-the-Money Call Options
Purchasing calls can feel safe as it matches the pattern that you are used to following while trading in equity. A lot of veteran traders started and gained profitability in the same way. But, buying OTM calls outright is a tough way to make money in the world of options. It makes sense to jump-start your options education by learning some strategies and enhance your potential to have solid returns while building your knowledge.
Using an All-Purpose Strategy in All Market Conditions
There is flexibility in option trading. It can allow you to effectively trade in all types of market conditions. However, you can just benefit from this flexibility when you still welcome new strategies. Purchasing spreads can provide an excellent way to capitalize on various market conditions. Also, purchasing a spread is called long spread position. Beginners in options trading must be familiar with potentials of spreads so that they can start to recognize the best condition to use them.
Failing to Have a Definite Exit Plan before Expiration
Planning one’s exit is not only about reducing loss on the downside. It is necessary to have an exit plan even if things are currently favorable. Traders must select ahead of their upside and downside exit points as well as their timeframes for every exit.
Doubling Up to Make Up for Past Losses
Often, doubling up as an options strategy does not make sense. Because options are derived, their prices do not move the same. Time decay must always be factored into your plans. If things change in the trade and you are contemplating the unthinkable, it is important to step back and ask yourself if that is a move you had taken when you first opened the position. Do not do it when your answer is no.
Trading Illiquid Options
Liquidity is about how quickly you can purchase or sell something without causing a substantial movement in price. A liquid market has ready and active buyers and sellers. When the stock is not liquid, the options may be even more inactive. Often, this will cause artificial widening of the spread between the ask price and bid for the options. The rule of thumb is when you are trading options, ensure the open interest is least equivalent to forty times the number of contracts you wish to trade.
Waiting too Long to Purchase your Short Options Back
When your short option gets out-of-the-money and you have the ability to purchase it back in order to profitably take the risk off the table, then do it. Avoid being cheap. If it is possible for you to keep at least 80 percent of your initial gain from the option’s sale, consider purchasing it back right away as a short option may bite you back after you waited too long.
Author Bio – Kim Klaiman is running a high ranked blog dedicated to options education.