Options can be used in any kind of market conditions to generate profit or hedge risks. When entering the options trading world, new traders are inclined to get entrapped in tight spot. When used incorrectly options have the capability to wipeout your account rapidly. Few common option trading dilemmas that novice trader encounters and ways to resolve them.
Buying OTM options
New traders are inclined to buy short OTM options because they are cheap. They are cheap because the probability that their value will be small, so traders will need to buy plenty of them to get a high pay off and manage.
You will need to be right on direction and timing, when buying these options. It seems simple but if you hold them for long even if it is moving in right direction their value will be small.
Straight long calls or puts need to be purchased ATM or ITM. Options will be expensive than OTM but success probability and leeway provided will be worth.
No trading Plan
The tight spot:
Regular trading stock position is different than options trading. You will need to monitor multiple factors. Besides enter & exit rule there is a lot of options trading strategies that can be applied to increase profits and mitigate the risks.
When there is no trading plan then the chances that your emotions will dominate your decision increases. Emotions cannot be eliminated from the equation but allowing it to make decision can bombard your portfolio.
Trading plan will define clearly the following aspects –
- When to get in?
- Which strategy to apply?
- What is your profit goal?
- What are your adjustment levels?
- How much loss is affordable?
- How to mitigate or manage risk?
Having a proper trading plan will help you stay for long in probability game.
New traders inevitably start with long calls andputs
with options. This is not wrong. The problem is that even though options provide traders multiple unique strategies they remain pigeon-holed and never venture out.
With options you get to trade in different scenarios like –
- Upward move
- Downward move
- No move
- Volatility increases
- Volatility drops
All option strategies are not for you but there are some which are suitable, so try them in small sizes. It doesn’t hurt to get familiar with them.
Avoid trading on instincts
Many beginners lose money because they opened a position without fully understanding of how options work.
You need to gain knowledge about how options strategies react to direction, time, and volatility. You can refer to it while placing a trade to avoid surprises, when the trade goes live.
Allowing short options go unchecked
Short options provide limited rewards but risks are unlimited. New traders can find it a turnoff but explore this strategy because it is capable to generate income. The only thing to keep in mind is always stay ahead of them. Monitor the downside as well as upside.
The crucial rule is never allow short options go ITM unless there is covered calls trading or applying puts to lift up stock. In case you allow options to go ITM without using these strategies then the chance to get assigned increases, which is bad. Before trading, set exit points on the basis of maximum loss number or technical analysis.