4 common errors option traders must avoid


I could have written mistakes but mistakes are more intentional in nature or maybe known wrongdoing, while errors are mostly matters that are out of sight. Most traders attracted by smaller lot sizes and smaller moves choose Nifty Options or Bank Nifty options to trade.

Trading them for starters is not wrong but there are a few things that we tend to overlook, which turn into errors that put us off options trading.

We will look at such errors and also remedies to avoid these mistakes.

1. Remember, time is not a friend but a foe for option buyers

Most of us start with buy options trade for the primary reason that it is one of the most inexpensive trades. While over a period of time we do realise that the time value phenomenon in the options premium will push the premiums down, in an attempt to chase the move, we do end up making the error of overlooking the time value-related drop (time decay) in option premium.

This eventually pushes us so back in premium that despite the view being right, we may not get satisfactory profits out of an option buy trade.

This is mainly because we all know about time decay but do not know how to account for it in options buying trades and that is the biggest error of all.

A simple way to tackle this is by taking a time-bound view of the stock or index we intend to trade with options buy trade. As soon as the time elapses, we get out.

2. Everything must not go (stop spending on premium if it does not matter to you)

The option premium is a tiny amount one has to pay to trade. The error is that this is often considered as the maximum loss. To trade options efficiently, we need to make sure that the premium paid is invested only till the validity of the view.

The remedy is simple, just like we trade any stock or index in cash or future, and keep a stop loss and target, maintain the same stop loss in the option trade as well. As soon as the underlying index or stock hits your stop loss, get out of the option trade. No point in waiting for an option where the underlying view has been invalidated.

3. Selling Call + Put without stop loss

Option selling is one of the most successful trades around financial instruments. However, selling options without foreseeing possible losses is one of the biggest errors one can commit, especially when one sells both Call & Put and imagines that loss in one is profit in the other.

Many traders take it easy on the stop loss or monitoring mechanism when they sell both Call and Put options. Remember, profit in one will not be able to fully compensate for the loss in the other if a big move sets in.

So, keep a total premium stop loss. This should not be more than 2X of your premium received. This is because if it does, we end up losing more than the most we could have made.

4. Strike selection mistake

Risk and return both are integral parts of the trade. With underlying being the same, option trade selection of strike governs the risk as well as return we can see for the same move in the underlying.

Selecting a too far away strike can reduce the return potential, while buying a too expensive Call or Put can pose undue risk.

Ideally, there are many option trading applications that help with the pay-off. Compare and check what works best for you.

Otherwise, a simple rule is that buy strike close to the current market price, which takes care of most of the factors that add to the profitability of your options.

We all know about these errors and remedies but it is still good to keep reminding ourselves of these for error-free options trading.

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