OPTION WRITING - 3 MISTAKES

As our markets are becoming mature, the number of option writers is increasing. It is believed than generally 80 % of option buyers loose money so what should we do..Option writing is other way round..

Option writing or in other words option selling means to sell option call and puts for a premium.

But while option selling can be a powerful way to diversify into a non-correlated, non-directional strategy, there is no free lunch. Writing options is one of those strategies that is easy to understand but infinitely more difficult to master.

Experience shows, however, that not doing the wrong things will have as much, if not more, an impact on your portfolio’s ultimate performance than doing all of the right things. Therefore, we can learn a lot from the errors of others. To that end, we’ll explore the three biggest mistakes that option sellers make and, more importantly, discuss simple ways to avoid making them.

Mistake one: Over-positioning

Over-positioning is the biggest mistake new option sellers make. Most brokers servicing self-directed clients will see this again and again. No matter how much you school them on how to sell options, it is difficult to teach somebody how to position.

Typically, this is how it works: New traders sell a few options, see them decay and get excited thinking they have found the Holy Grail of investments. They proceed to ramp their activity to ridiculous levels, selling far too many options relative to their account size and end up with either too many options for their account or too concentrated in a particular market or sector. Option selling works but you have to understand and respect the leverage.

Some simple guidelines can go a long way toward protecting against over-leverage: Keep 50% of your account capital in cash and diversify your other 50% among at least six to eight options, puts and calls

Mistake two: Selling too close to the money

Many option selling proponents will tell you that the best way to sell options is to select strikes with fewer than 30 days remaining until expiration. The reasoning is that you get the maximum rate of time decay  This approach may have its merits, and it certainly looks good on paper, but it has one major drawback: To get any premium at all with this strategy, you have to sell quite close to the money. In the futures market, this can mean selling perilously close

Mistake three: No exit plan

While most all investment books, courses and articles talk about risk management, you would be surprised to learn how many traders just wing it. They get excited about entering a trade and don’t bother to think about what they will do if things don’t go as planned. When they do get a trade that isn’t working, they can often experience altered judgment or, worse, panic and overreact regardless of where the market is.

The point is there are several ways to manage your risk. Some writers use hard stops while others roll out positions to further out strikes and contracts. The important thing is that you have an exit plan in place. That way, when the market or your option reaches a certain level, you know exactly what to do. You are not reacting emotionally.

Succeed by not failing

Option writing is a strategy that can seem easy. Don’t be fooled or become over confident. Putting the odds in your favor -- which is what you are doing when writing options -- does not protect from the spikes in volatility that often wipe out even experienced option writers. For beginning traders, whether you are selling commodity, equity index or equity options, the first step isn’t to excel. The first step is to not fail. Avoiding these three mistakes will keep you in the game as you hone your option selling skills and learn the intricacies of the markets you trade. It will take you a long way toward becoming an effective option seller for years to come.