Today’s Trading Lesson From TradingMarkets
Editor’s Note:
Each night we feature a different lesson from
TM University. I hope you enjoy and profit from these.
E-mail me if you have
any questions.
Brice
PS To learn professional options strategies, try the
TradingMarkets Options College.
Seven Mistakes
Novice Options Traders Make
By Len Yates
-
Thinking
of an option like a stock. An option
can go to zero much faster than a stock! You
have to act quickly if it starts to go the wrong way. -
Buying
out-of-the-money options because
they’re cheaper. Yes, they’re
cheaper, but they’re less likely to reward you with a gain because
you’re asking the underlying to jump through a smaller hoop.
Buy a smaller quantity of in-the-money options and you’ll be more
satisfied with the behavior of your option as the stock jiggles and chops
its way in your direction.
-
Buying
options without regard for the current volatility level.
Recent volatility makes options more expensive.
If you buy expensive options, you may be hurt when the market settles
back down. -
Thinking
that covered writing both lowers your risk and increases expected return.
Covered writing (selling calls against shares of stock) is often
presented using numbers like “return if stock unchanged†and “return
if stock is called away,†both very favorable outcomes.
When the whole picture is considered (including the stock going way
down or way up), covered writing lowers risk and lowers expected returns. -
Believing
that there is a certain option strategy (e.g., covered writing, vertical
spreads, horizontal spreads, etc.) that has positive expected returns in the
long run. There is no magic options
strategy that makes money. Traders
must pick a strategy to apply in each situation that sets up the desired
risk/reward profile. -
(Extension
of #5) Believing that selling options (naked or covered) has positive
expected returns in the long run. Don’t
get too concerned with the time decay nature of options.
An option’s time decay is offset by potential movement in the
underlying. The result:
A fairly valued option conveys no edge to a seller or a buyer. -
Lack
of preparation and education. Read a
book or two, attend a seminar, select good trading software, and do some
“paper†trading before diving into the real thing.
When ready, select an options-friendly brokerage, and start trading
with small, easily manageable positions.
Three
reasons investors mistakenly avoid trading options1
-
“Options
are too risky.†Although options can be used to speculate on short-term
moves, they can also be used to lower the risk of a stock portfolio.
They can also be used in place of stocks to invest in long-term (up
to three years) moves. There are many
different ways of using options, some of them risky, some of them not. -
“Options
are too complex.†Options are
kind of like the game of chess. You
can learn the rules and be ready to play in just 20 minutes!
Of course, then there’s a few strategies you need to become
familiar with. However, while chess
variations are practically infinite, in options there are just a handful of
different strategies, and it’s not necessary to know them all before you
get started. -
“Options
are too expensive.†On the
contrary, options can be bought for as little as a few hundred dollars each.
1Extract
from the forthcoming book,
“The Global Investor Book Of Investing Rules.”