Mistakes are inevitable, but one can constantly get better at trading if they learn from them and refine their approach. Some mistakes are more harmful than others. Here’s a list of the top 5 mistakes that have cost traders heavily and what you can do to avoid them.
1. Lack of trading framework: Most options traders start out without a framework or strategy. This is the first mistake that cascades into inconsistent results. Thus it is imperative that traders adopt a simple but effective framework of clearly setting a target, stop loss and time frame for any trade well before entering into one.
2. Buying far out of the money options: Traders prefer far out-of-the-money options as they are cheaper to buy. These can be profitable in a trending market, but it hurts the overall strategy if the market or stock remains range-bound or doesn't make a big move. It is crucial for a trader to not give in to the lure of “cheap options”, instead choose the right strike price which allows you a quick exit if the market moves favourably. Usually, this means buying at-the-money options or out-of-the-money options closer to the current market price.
3. Misunderstanding risk: Options buyers are aware that the maximum loss they can incur is the premium paid, but the maximum profit is (potentially) unlimited. This is enticing but misleading on two fronts. First, while the profits can be high, a lot of factors must fall in place for options traders to book profits. Correct market view, proper strike price selection, options liquidity and a disciplined approach to name a few. Second, though the amount of loss is limited to the premium paid, risk is always calculated in terms of the percentage, which in options buyers case can be 100%. Thus, in hopes of “unlimited” profits options buyers often end up taking the biggest risk of losing their entire capital invested.
4. The role of time decay: “Time is always against us”. Well, this is undoubtedly true for options buyers. Time decay eats into the premium as expiry approaches. This hurts options buyers the most, who initially remain in the hope of a significant movement to book profits but ends up giving it all in the end. The best way out of such trades is to have a disciplined approach, to begin with, and implement it rigorously (refer to point 1).
5. Not being open to new strategies: One strategy does not yield profits in all kinds of market trends. You need different horses for different courses. Traders must learn and implement different options strategies for different market conditions. This essentially improves their chance of making profits and diversifies risk.
Which of these mistakes have you been making? Let’s stop these pitfalls and UP our trading experience. Upstox will soon launch its advanced options strategy builder for all its platforms. Through the strategy builder, you will have a disciplined approach, better downside protection, automated P & L calculations, and above all, a hassle-free multi-leg order placement in just 3 clicks. So, stay tuned.