The most common options trading mistakes are ignoring the Greeks, buying cheap deep out-of-the-money options, selling options without a hedge, sizing positions without measuring value at risk, and trading on emotion. Each one can be reduced with a written trading system, hedged positions, defined-risk strategies, and a clear view of your own trading style. This article covers the five mistakes first, then the fixes.
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Let us look at the common mistakes that traders do in trading options:
1. Ignoring The Greeks –
Options are derivative instruments whose value is derived from the underlier. Option Greeks are financial measures of the sensitivity of an option’s price to its underlying determining parameters, such as volatility or the price of the underlying asset. The Greeks are utilized in the analysis of an options portfolio and in a sensitivity analysis. Greeks are in general difficult to understand for novice traders and often ignored, which leads to losses for the traders.
2. Buying Deep Out Of The Money (OTM) Calls/Puts –
Many times, we observe traders buying deep OTM calls/puts just because they’re very cheap and it allows the traders to buy a larger quantity. However, many beginner traders do not realize that deep OTM options need a large move in the underlying before expiration just to break even, so most of them expire worthless.
3. Option Selling Without Hedge –
Buying options involves limited risk as the option buyer’s maximum loss is only limited to the premium paid. When it comes to option selling, the losses are not capped by the premium received, and they are unlimited for a naked short call. A single large move against an unhedged short option can wipe out months of collected premium, or more. Hence, option selling without a hedge involves high risks.
4. Value At Risk –
Traders at times, enter into trade positions without calculating the value at risk (VAR). Not understanding the leverage correctly and taking improper position sizing can result in huge losses if the view goes in the opposite direction of the trade taken.
5. Letting Emotions Do The Trading –
Options trading involves high volatility and we have often seen the best traders making losses because their emotions kicked in the trade. Greed and Fear are a trader’s worst enemies and they often lead to heavy losses because we let the emotions take control of our trading decisions.
How to avoid these options trading mistakes
1. Develop A Trading System –
Having a trading system helps a trader remain disciplined. A trader should be aware of his potential profit/loss even before he enters the trade. This will remove the emotional aspect of the trade.
2. Hedge Your Bets –
A trade can either go right or wrong. When it goes right, we get good profits. When it goes wrong, a hedge (for example, buying a further out-of-the-money option against a short option) caps the loss, including the overnight risk of carrying the position.
3. Build Strategies –
The beauty of options trading is that an option trader can make a profit in a bull market, bear market, and even a sideways market. How?! By building options strategies, just like we offer a wide range of templates at MarketXLS! Do check them out –
4. Understand Your Trading Style –
Every trader is different and has a different style of trading. It is thus important for a trader to understand his/her trading style and not get carried away by what other traders are doing. Knowing when to trade is important but knowing when not to take a trade is equally important too.
Bottom Line –
We hope that this article clarified the risks and strategies to avoid those risks for you.
To further ease out your job with options trading, we suggest you use** MarketXLS templates** for your portfolio management which pull options data into Excel. Options data is end-of-day on the Standard plan and real-time streaming on the Advanced and Business plans (see pricing).
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