Top options trading mistakes that you should not make

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by tinkerprophet

IMO, trading options have similarities to playing poker and in order to be successful in the long run you need to be disciplined and refrain from making common mistakes. I’m going to list common mistakes and some tips here. Please suggest more. Hope we all lose less tendies!

  1. Refrain to trade low volume options . These contracts will have really wild bid/ask spread, or really low volume, which reduces your chance to make profit significantly. For example how can you win if you trade $ROPE 100c when the bid ask spread is $69/$96 per contract?
  2. Refrain to trade very low price options (e.g 1-10 cents) because your broker commissions will eat up a significant amount of the transactions. Think how much commissions you have to pay to buy 10000 contracts of 0.01 $ROPE 1000c which costs $10000 of premium.
  3. Refrain to buy near-dated far OTM options, because this is almost a sure way to burn your money. Even worse, even if you guess the direction right, you may still have a substantial loss. Think $PEI 500% OTM 2DTE. Btw $PEI is a great stock to own. Example: on 04/13 you bought SPY 496c 04/17 when SPY=280. On 04/14 SPY rises to 285. Guess how much you made on your call options?
  4. Know when to select OTM vs ITM options: in general: OTM is higher risk/higher return. Have some sense of OTM price movement – even when you guess the direction right, far OTM options won’t make you money because of low delta. ITM is more expensive. ATM is typically a safe choice if you just want to make a directional bet.
  5. Know theta-crush. Your options will lose time-value every day, so refrain from buying short-dated options unless you know what you’re doing.
  6. Know the effects of IV (VIX for SPY) on options price. Sometimes even when you guess the direction rights, you may lose money because of VIX movements. Know how to hedge for VIX movement.
  7. Refrain from using market orders when possible: limit orders will give you the price you want.
  8. Understand the margin impact of different options strategies.
  9. Understand the impact of your broker commissions.
  10. Bank management: never YOLO your entire portfolio into one position, because if you lose, there’s 0% chance to make it back. Learn If you want to get in a large (50K+) position, average in/out may be a good idea.
  11. Don’t open too many positions unless you’re a bot. It’s hard to manage manually and easy to make mistakes.
  12. (Mostly) don’t follow autist DDs that you can’t explain.
  13. Learn the market hours!
  14. Options strategies can be complex to visualized. Use your broker’s performance profile tool to understand the performance implications before making a trade.

Some risky options strategies that you should only do when you know what you’re doing

  • Naked puts, i.e. short puts: very risky especially in a recession: when the underlying crashes you’ll lose lots of money
  • Synthetic shorts: i.e. long puts + sell calls, also very risky, only know when you’re 90% sure of the direction.
  • Naked calls, i.e. short calls: also pretty risky if the underlying moons.

Less risky options strategies:

  1. Covered calls: very low risk. You hold shares, and sell OTM calls to cover them and collect the premium.
  2. Cash secured puts: sell puts but you have cash to cover it. This is good when you’re willing to buy the shares if it drops, otherwise you collect the premium.
  3. Diagonal: Simultaneously entering into a long and short position in two options of the same type (two call options or two put options) but with different strike prices and different expiration dates. Typically these structures are on a 1 x 1 ratio. This is less risky and can hedge you against IV as well. For example if you bearish on USO, buy a 4p 05/15 and sell a 3.5p 04/24, that way if USO moves upward on the week ending 04/24 you’ll collect the near-dated premium.
  4. Learn how to sell options. Every mistake you made as an option buyer is probably a chance for you to profit as an option-seller.

Practical tips

  1. Use tools to scan top volume options. . This can give you some confirmation.
  2. Use tools to scan unusual activity options. Try to think why people are making that trade. Your broker also has tools to scan these.
  3. Take advantage of L2 flow data if your broker provides.
  4. Sometime when you can’t make a long-term directional bet, it may be profitable to day-trade or swing-trade (hold your positions for 1-3 days).
  5. Know common ETFs:
  • SPY: everyone knows this. The most liquid options to trade.
  • IWM: tracks Russell 2000. Also pretty liquid. Trade this if you don’t want expose to big techs.
  • Sector specific ETFs: XLE, XLF, XLC, etc. Also highly liquid.
  • Country specific ETFs: EWU, EWG, EWC, EWA, EWJ … fairly liquid.
  • Gold: GLD
  • Silver: SLV
  • Oil: USO (make sure you really understand this; it doesn’t track oil price)
  • Options of individual stocks: in general, the more liquid the underlying, the more liquid the options, e.g. AMZN, BA, FB, TSLA, …

Tips to improve

Learn more about economics and business to improve your common sense.

Advanced topics: understand how MM works, gamma hedging, dark pool indicators, probably understand some TAs such as RSI.

Day trade dynamics: power hours.

Things to debate

  1. Should you use stop-loss orders or not?
  2. When to buy FDs and how much should you spend on FDs?
  3. What is the impact of the underlying delisted on put options? As example OILU closed on 03/29
  • On March 15, 2020 ProShares Capital Management LLC announced that it plans to close and liquidate ProShares UltraPro 3x Crude Oil ETF (ticker symbol: OILU) and ProShares UltraPro 3x Short Crude Oil ETF (ticker symbol: OILD). Each fund trades on NYSE Arca. The last day the funds will accept creation orders is March 27, 2020. Trading in each Fund will be suspended prior to market open on March 30, 2020. Proceeds of the liquidation are currently scheduled to be sent to shareholders on or about April 3, 2020 (the “Distribution Date”).
  • Shareholders may sell their shares of a Fund (subject to any applicable brokerage or transaction costs) until the market close on March 27, 2020. From March 30, 2020 through the Distribution Date, shares of the Funds will not be traded on NYSE Arca and there will not be a secondary market for the shares. During this period, each Fund will be in the process of liquidating its portfolio and will not be managed in accordance with its investment objective.
  • These strategies are intended to allow an Oil Fund to preserve a minimal portion of its value in the event of significant adverse movements in a Fund’s benchmark. There can be no guarantee that an Oil Fund will be able to implement such strategies or that such strategies will be successful. Each Oil Fund will incur additional, potentially substantial, costs as a result of such strategies which may cause or increase tracking error and would be expected to have a substantial adverse impact on performance. Use of such strategies would cause an Oil Fund to not perform consistent with its investment objective. Furthermore, in the event that an Oil Fund’s value decreases by 70% or more at any point from its prior day’s NAV, as determined by the Sponsor, the Sponsor, in its sole discretion, in order to maintain the integrity of the ongoing operation of the Fund or for other reasons, may cause such Fund to liquidate some or all of its positions and, in lieu of such positions, invest such assets in cash or money market instruments. The above actions may be taken without prior notification to shareholders and would be expected to cause an Oil Fund not to perform consistent with its investment objective. Under these circumstances, consistent with its general authority, the Sponsor may, but is not obligated to, cause an Oil Fund to be terminated and dissolved.



Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.


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