You must have heard that trading in options market can help you make a lot of money when the stock goes down or up.
We usually use options to hedge our positions in the equity market, reduce the losses, and protect our profits.
But what if one of your options strategies goes wrong, you may incur a large amount of losses too.
This is the reason you should start trading in options with caution.
|Table of Contents|
|Trading Options without Knowledge|
|Buying Out-of-the-Money (OTM) Call Options|
|Trading Illiquid Options|
|Limiting to one Strategy|
|Selecting the wrong Expiration date||Neglecting Volatility|
|Ignoring event calendar|
7 Mistakes to avoid while Trading in Options
1. Trading Options without Knowledge:
The first mistake that every novice trader makes while trading in options is lack t.
Trading in options is quite difficult without having proper knowledge of it.
There are many basic options terms like call, put, premium, margin, strategies that an option trader should know before jumping to trading in options.
They should also know about different types of options, greeks, historic, and implied volatility as they are important parameters when it comes to analyzing the options.
Without gaining knowledge traders may incur losses in the market and they get discouraged.
2. Buying Out-of-the-Money (OTM) Call Options:
New options traders get attracted to buy OTM options as they are cheap but buying OTM call options are one of the hardest ways to make money consistently.
Those who buy OTM call options follow the strategy of buying at low and selling at a higher price.
But limiting to this strategy will not help you in making profits consistently.
What if this strategy fails for one of your trades?
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You will end up making in a large amount of losses from this one trade. This is one of the biggest mistakes traders make while trading in options.
Instead of this one should consider selling an OTM call option on a stock that they already own as their first strategy.
3. Trading Illiquid Options:
Liquidity refers to how quickly one can buy or sell something without a significant price movement.
A liquid market is the one that has active buyers and sellers.
Stock markets are usually more liquid than option markets as the traders are trading in just one stock whereas the option traders have many options contracts to choose from.
For example, stock traders will just need to select Reliance stock to trade, but options traders have to choose from different expirations and strike prices.
Also one should try to choose options of the underlying assets that are liquid.
4. Limiting to one Strategy:
As we have discussed above, the option traders should not limit to one strategy when it comes to trading in the options.
There are a number of options trading strategies available like covered call, straddle, and strangle and so on.
Depending on the market situation and price movement, the option traders should try to implement different types of strategies.
5. Selecting the wrong Expiration date:
It’s usually difficult for the novice traders to choose the expiration date and they end up selecting the wrong one.
When selecting the right expiration date, the option traders have to consider certain parameters.
Liquidity in the underlying assets, the timeframe in which the prices could move to the expected levels, results, or any corporate actions that are going to be announced by the company are some of the factors that traders should look when choosing the expiration date.
6. Neglecting Volatility:
Implied volatility is a measure of calculating the expected volatility for a particular stock in the market for the future.
Option traders should analyze if the implied volatility is low or high, which helps in determining the price of the option premium.
The traders should analyze if the premium is expensive or cheap that helps in selecting the option strategy that they should take when trading in options.
7. Ignoring event calendar:
Option prices usually react when an event is coming like dividends or bonus shares.
Investors tend to read the increasing value in options as a sign of a big move in its current direction.
For example, price movement in the option at the time of Infosys results announcement tends to raise without any a rise in the underlying stock.
Thus it is important to keep a track of the event calendar.
Above are some of the mistakes that novice options traders usually make when starting trading in the options.
One should remember that a successful options trader is the one who keeps learning from the mistakes they make when trading in options.
- Options are used to hedge our positions, reduce the losses, and protect our profit.
- Options traders should not limit themselves to only one strategy.
- Options traders should keep a track of the event calendar as they affect the prices.
- When selecting the right expiration date, the option traders have to consider certain parameters.
- Option traders should analyze if the implied volatility is low or high, which helps in determining the price of the option premium.