Friday, July 3rd, 2020

Three Options Trading Mistakes to Avoid


There are three basic options mistakes that both rookies and pros can make at times. These three options trading mistakes to avoid are trading non liquid options, not having an exit plan and doubling down to make up for losses. First we look at the matter of illiquid options.

Trading Non Liquid Options

The point of trading options is to hedge risk and make money. What you do not want to do is give away 12.5% of the value of the trade when you start. This can happen when you trade non liquid options. There is always a spread between the bid and ask price for an option. The wider the spread the more non liquid the option is. The actual value of the option is in the middle. Liquidity comes from trading options on an equity that has decent trading volume and enough interest that the base equity is trending up or down. If you are going to trade a non liquid option of a stock with a bid price of $2 and an ask price of $2.25 you are giving away 12.5% before any chance of a profit. This is the first of our three options trading mistakes to avoid. There is conservative options trading and there is risky options trading. But trading non liquid options is just plain dumb.

Not Having an Exit Plan

Always know what to do if things do not work out. The second of our three options trading mistakes to avoid is not having an exit plan. Exit plans are not just about minimizing losses but also about getting out with a profit before the trade turns around.  There is also the matter of having made money on a trade and staying with it to eke out a little more profit when you could just take your money and go on to another profitable trade. The point is to choose your exit points in advance. How much will you be happy to earn on a trade and how much are you willing to lose? Decide this up front. You can always change your approach after analysis of trading results but do not change the rules in the middle of a trade. Too many traders are worried about leaving money on the table if they exit too soon. And too many traders stay with losing trades, too stubborn to admit their mistakes and move on to a new trade. Create an exit plan and use it. You will make more money, lose less and sleep better. And if you are trading options in a very volatile market and do not know which way to trade, consider a strategy such as a long straddle that will pay you if the equity goes up or down.

Doubling Down to Make Up for Losses

The options market is not the casino. If you are losing money on a trade and your fundamental analysis and technical analysis tell you that it is time to get out of the trade, get out. And do not push more money into a losing proposition. This is the third and perhaps most important of our three options trading mistakes to avoid. Incorporate this into your options trading strategy and you will be happy in the end.

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