While there are many articles explaining common mistakes in options trading, I thought it may be more helpful to learn with some examples of what happened when I personally made these mistakes. Hopefully after seeing how much money I have lost, you will be more careful in not making them!
*Disclaimer: There are a handful of traders who make these “mistakes,” and remain very successful. The goal of this article is to just show my personal experience playing with fire, so you can be more aware of the potential consequences when doing so.
1. Buying Calls or Puts (especially OTM)
Starting off with my very first wall street loss is buying OTM calls/puts. If you are unfamiliar with this strategy, buying OTM calls/puts is a cheaper option with a lower POP.
Cheap Option= You do not need a lot of buying power
Low POP= The odds of winning are not in your favor
Many rookie traders are drawn to this strategy because it is easy to understand, and also does not cost you a lot of money. HOWEVER they are cheap for a reason- low odds.
What about buying ATM and ITM calls/puts?
While not as bad as OTM, ATM and ITM long options are IN MY OPINION not the smartest trade.
Why?
The odds are against you- BY A LOT
For example (and these are the current prices/metrics for this trade as I am typing this): If you buy an ATM call in SPWR for $2.46, at a strike price of $30, assuming the option is held until expiration, you would not even break even on this trade until the stock price reached $32.46.. this is almost a 10% move. Further the POP for this trade is ONLY 33%. In other words:
You are risking $246, betting on at least a 10% stock move, with only a 33% chance of it actually happening…
*Disclaimer- This is assuming an option is held until expiration for there are more factors that go into the price of an option.
The price I paid for this mistake- $900
If you are curious, I bought a bunch of calls in SPWR. I won some, but my losses heavily outweighed my gains. While I am a firm believer that you can make any strategy work, it is my opinion that winning overall with this strategy is very difficult to achieve.
2. Emotional Trading
This mistake is much harder to avoid than you would think, at least for me. Emotional trading involves pulling out of a trade because of fear of losing, or getting into a trade because of your excitement for a potential gain. My best advice is to learn how to make data driven decisions, and never trade out of a gut feeling.
The price I paid for this mistake- $1,400
In short, the news had some damaging information about the stock I had a position in. I panicked, rolled my position, and then closed it out of fear. A couple days later the market corrected itself and I would have been fine.
If you struggle with emotional trading, you should consider cutting out business news until you are more confident with your trades. Also, acting as a segue into my next mistake- Make sure you have a trading plan.
3. Not Having a Plan
If you go into a trade just winging it and not knowing when you will take your profits/losses, not knowing how long you will stay in a position, etc. you are in for a roller coaster of emotions. Not having a plan will make you more inclined to emotional trading, and you will also never be able to find a strategy that works for you.
In other words, if you do not have a plan, it will be very hard for you to find a way to make consistent income with your trading.
The price I paid for this mistake- $1,400
This mistake goes hand and hand with my biggest emotional trade. If I would have had an exit plan, or any kind of management plan, this loss could have easily been avoided.
Developing a plan takes time, but for now the best thing you can do for yourself is make an excel sheet with all of the details of your trades. This way you can visually see what works and what doesn’t. Where do most of your losses come from? What strategy works best for you? etc. In a later article, I can review how to set this up.
4. Not Allocating Capital Evenly Throughout Positions
Imagine that for every 10 trades you make, 9 are successful. Without much thought, this is seemingly a foolproof way to make money. However, if the one trade you are losing has significantly more capital than your 9 winners, you could be operating at a loss.
The price I paid for this mistake- $1,000
Overall, in calculating my monthly income I had a 90% success rate. However, my two losing trades happened to also be my largest trades. Even though I won most of my trades I still had a net loss of -$1,000 that month.
5. Earnings Plays
To be honest, I do not see an issue with trading around earnings if you are an experienced trader. As a beginner however-
Do not place any trades when an earnings report is coming up.
When a stock reports earnings, often times there is a big move in either direction. This will either be very good for you, or very very bad.
The price I paid for this mistake- $2,000
As I first started trading, I quickly realized the effect earnings could have on my position. I took some small losses from this, and consequently just started to make sure that a stock did not have any earnings reports coming up before I placed my trade.
As I got more experienced, I started participating in earnings plays. Won some, but took my biggest loss- $2,000 from an earnings play on AMZN. I now choose to just stay away from earnings all together.
Summary
While many traders have made a lot of money doing some of the things I have listed here, this article was meant to educate you on the risks involved with these “mistakes.” In my next article, I will be going over how you can set up a trading plan so please subscribe if you are interested in that!