3 Common Options Trading Mistakes to Avoid
There are certain futile trading habits that you’re better off doing away with in the long run. Everyone is capable of making options trading mistakes, but maintaining the same tradition and making the same decisions could result in repeating these mistakes.
Here are five commonly made mistakes that you should ultimately try to avoid to stay on top of your trading game.
1. Neglecting to Develop a Good Exit Strategy
Similar to when trading stocks, you need to make sure you have your emotions under control. This simply means that you should have an effective exit plan in place to avoid being trapped when the situation gets ugly.
And once you have that plan in place, it’s important to stick to it, regardless of whether or not your gut reaction is to back out from it.
Remember that an exit plan doesn’t simply consist of a plan to minimize downside loss; you also need an upside and downside exit point figured out. Options are also a decaying asset, and it’s important to keep in mind that the decay will grow faster as the expiration date approaches.
This means that if you’ve overestimated a put or a call and things don’t pan out within the anticipated period of time, it’s time to back out and try another trade.
2. Doubling Up to Compensate for Previous Losses
Traders typically have their rules set in stone, including never buying out-of-the-money options or selling in-the-money options, but somehow they still forget these rules until it’s too late and their trade is working against them.
Most traders have been in that situation and know that feeling when a trade is doing the exact opposite of what they wanted, which makes it tempting to break all personal rules and stick with the same option used from the start.
As a result, many “double up” to make up for these losses, which simply doesn’t work. Instead, simply accept that things aren’t working out, back out from the trade, and move on.
3. Taking Too Much Time to Buy Back Shorts
Traders will likely benefit if they are always willing to buy back short strategies early on when a trade is going south. Some of the reasons investors may not want to back out include the fact that it’s a pain to pay the commission to back out of the position, betting the contract will become worthless once expired, or simply hoping to earn a bit more money from the trade, among other reasons.
Traders will do well to buy back short options once they are out-of-the-money to remove the risk from the table and subsequently profit, if this is possible. Avoid being cheap.
While chances are you’ll make a mistake along the way when learning options trading, you don’t have to repeat them, and knowing about them can help you acknowledge the signs of when they’re about to be made.