1: Starting out by buying out-of-the-money (OTM) call options
It seems like a good place to start: buy a call option and see
if you can pick a winner. Buying calls may feel safe because it matches the
pattern you’re used to following as an equity trader: buy low, sell high. Many
veteran equities traders began and learned to profit in the same way.
2: Using an “all-purpose” strategy in all market conditions
Option trading is remarkably flexible. It can enable you to
trade effectively in all kinds of market conditions. But you can only take
advantage of this flexibility if you stay open to learning new strategies.
Buying spreads offers a great way to capitalize on different market conditions.
When you buy a spread it is also known as a “long spread” position. All new
options traders should familiarize themselves with the possibilities of
spreads, so you can begin to recognize the right conditions to use them.
3: Not having a definite exit plan prior to expiration
You’ve heard it a million times before. In trading options, just
like stocks, it’s critical to control your emotions. This doesn’t mean
swallowing your every fear in a super-human way. It’s much simpler than that:
have a plan to work, and work your plan.
Planning your exit isn’t just about minimizing loss on the
downside. You should have an exit plan, period – even when things are going
your way. You need to choose in advance your upside exit point and your
downside exit point, as well as your timeframes for each exit.
4: Compromising your risk tolerance to make up for past losses by
“doubling up”
I’ve heard many option traders say they would never do
something: “…never buy really out-of-the-money options!”, “…never sell
in-the-money options!” It’s funny how these absolutes seem silly – until you
find yourself in a trade that’s moved against you.
All seasoned options traders have been there. Facing this
scenario, you’re often tempted to break all kinds of personal rules, simply to
keep on trading the same option you started with. Wouldn’t it be nicer if the
entire market was wrong, not you?
As a stock trader, you’ve probably heard a similar justification
for “doubling up to catch up”: if you liked the stock at 80 when you bought it,
you’ve got to love it at 50. It can be tempting to buy more and lower the net
cost basis on the trade.
5: Trading liquid options
Simply put, liquidity is all about how quickly a trader can buy
or sell something without causing a significant price movement. A liquid market
is one with ready, active buyers and sellers at all times.
Here’s another, more mathematically elegant way to think
about it: Liquidity refers to the probability that the next trade will be
executed at a price equal to the last one.