Top 5 Mistakes New Option Traders Make & How To Avoid Them

Published on Thursday, August 9, 2018 by Chittorgarh.com Team | Modified on Wednesday, February 28, 2024

Options Trading Mistakes to Avoid

Options trading is a great way for savvy traders to make money by leveraging assets and managing risks. Options allow you to make profits in all market situations - up, down, or sideways. They are also a popular tool for hedging your investments. However, if you are new to the options business, it can seem overwhelming. A new world!

As you familiarise yourself with options trading, there's a good chance you will make mistakes that result in losing money. Some of these mistakes are even made by experienced traders. In this article, we will discuss the 5 most common mistakes that new options traders make and how to avoid them. Understanding these mistakes will help you avoid costly trades and make informed trading decisions.

Top 5 Mistakes New Option Traders Make (Common mistakes in options trading)

Mistake #1: Trading without a plan

Most new traders start trading without a plan - on the advice of a friend or after being inspired by an article in a financial magazine. Trading without a plan is like driving a car without a destination. The result: loss of time and money.

So start with a solid trading plan.

How to create an options trading plan?

Your trading plan must include the following-

• The amount of money you are willing to invest each month and each trade.
• The type of options you want to invest in - stocks, Nifty, Bank Nifty, commodities, etc.
• Expected return from the trades.
• The risk or loss you are willing to bear/absorb.

In every trade, you need to stick to your plans. Resist the temptation to deviate from your plan and invest too much or risk too much. Good traders have their greed and fear under control and are therefore able to make rational trading decisions.

Start small with your investments. You can learn a lot by reading about options. But you will learn even more when you trade options. So start small and then go all out.

Mistake #2: Adopting a one-size-fits-all strategy

Predicting the market trend and choosing the right strategy are the secrets of options trading. A specific strategy may bring one-time profits, but repeating it is a sure recipe for disaster.

How to predict the market outlook?

Experienced traders make market predictions based on fundamental and technical analysis of stocks. They also take into account micro and macroeconomic factors. So learn how to conduct technical and fundamental analyses of shares to be successful in the long term. Read the opinions and views of experts on various websites and in magazines.

The next step is to choose the right strategy that fits your market outlook.

How to choose the right options strategy?

Our Options Strategy Guide is one of the ways to understand different options strategies. We have compiled a list of 25 strategies for different strategy levels, market outlook, risk and reward potential, etc. You can also compare the strategies to find the right strategy for your outlook and trading preferences.

Mistake #3: Buying out-of-the-money (OTM) call options

New traders get attracted to buying OTM call options. It is for two reasons- OTM call options are cheap and easy to understand & trade. You buy at a lower price and sell at a higher price. Very few understand that Option pricing is not only dependent on the upward movement of the price of its underlying but also the probability of reaching the strike price and the time decay.

Buying OTM Call options can result in losses even if your market outlook is bullish. You need to select the right strike price and must have sufficient time in your hand. So, don't just buy OTM Call options. Buy it only when it makes solid trading sense.

Mistake #4: Lack of an Exit Plan

Most new traders don't have an exit plan. This stems from not having a target for profit or loss. How much money do you want to make from a trade? How much loss can you absorb? Do you want to sell the Options before expiry or want it to expire worthlessly? You need to know how to build an exit plan. An exit plan is essential for Options trading because it is time-bound. Unlike stocks, you cannot keep it on hold for a long time and wait for recovery. Also, there is a variance in taxation on selling or expiring options.

'STT for selling options is 0.05% but, if you carry your trade till expiry and your options are in-the-money (ITM) and get exercised, then you will be charged 0.125%'.

Prepare an exit plan before you execute the trade. And stick to it. Have a realistic goal and sell when you have achieved it. Also, have a target for losses you can absorb. Once your trade hits the loss mark, exit from the trade.

Mistake #5:- Not Keeping an Eye on Time

One of the biggest mistakes new options traders make is not taking time decay into account. Also, many traders buy trades just before expiration when option prices are low. Time is one of the main differences between stocks and options. Time decay plays an important role in the pricing of the Options. With each passing day, the value of your options decreases.

Always take time into account when considering a trade. Keep an eye on the time and make your trades in the first few weeks of the options calendar.

There is a well-known saying that we learn from our mistakes. This also applies to options trading. But we must also learn from the mistakes that others have made. Avoid these mistakes that new options traders make and save yourself from losses.