I think I’ve made just about every option trading mistake you can make when trading options. However, I always learn from my mistakes. Most of the time.
If you have been trading options no doubt you’ve likely made some as well. Let me know your biggest mistake in the comments below. Biggest mistake wins!
In this video we are going to cover the top mistakes that beginners make when trading options. If you are fairly new to trading options you are going to want to watch this.
In this video we are going to lay out:
- The Top 8 Mistakes Beginner’s Make When Trading Options
- All are equally important so be sure and watch to the end
——————————————————————–
Hey guys, Darren here. Thanks for joining. We talk about using options to increase profits and reduce risk in your trading portfolios.
I promise that we will dig into many different detailed option trading tips and tricks, and dive much deeper into options in future videos. So please subscribe if you haven’t already.
It’s super important to understand the mistakes we make when trading options. Why is that? So that we don’t continue to make them again and again. And most importantly because when we make mistakes what do you think it means?
We lose money. We don’t want to lose all our money to where we don’t have any left for more mistakes.
————————————————————
Before we get started, be sure to download the FREE options Workshop in the link below.
It talks about the two main benefits of trading options over buying stocks.
DISCLAIMER, I am not a financial planner and I am not recommending trades. Please do your own research and if you are new or learning options, I recommend you start small.
—————————————-
Please tap that like button and let’s begin.
Mistake #1 – Not Planning Your Trades
Failing to plan is planning to fail. I think my Dad used to tell me that.
Having an exit strategy in place before you ever make a trade is extremely beneficial.
Successful people tend to have plans and then go about setting small goals that lead them towards accomplishing their bigger goals. Yeah yeah yeah……
Trading can be emotional. Both when trades go for you and when they go against you.
You don’t want to have a stock move against you and then just double down and hope it goes up.
Also you don’t want to have a big gain and then just add to it thinking it’s all roses.
You will be in a better position to make a correct decision if you have a plan before a stock moves either for or against you.
Mistake #2 – Trading Illiquid Stocks
New traders often don’t trade liquid underlyings. What I mean is that they don’t trade the big stocks like Apple or Amazon that have high volumes and are very liquid. Instead, they try to pick the next big winner that’s going to go up 100% or more.
Remember Wall Street Bets? The Meme stocks? A lot of people thought “Let’s buy some Calls in Gamestop and AMC” …We all jump on board and they’re going to the moon! Yeahhh….good job.
So once you get into an illiquid stock it’s tough to get out without giving up a lot of money.
Let’s look at an example of an illiquid stock on the Tastytrade platform. It’s the best platform for trading options. I’ll put a link down below and you can get a cash bonus when opening an account.
I actually really like this company Illumina as they are the global leader in DNA sequencing. But you unfortunately just can’t trade the options. The bid-ask spread is just too wide!
We see the trading volume is just 100K shares which is very low. We generally like to see over a 1M shares traded. Taking a look at the 180 Put option and we see the Bid is $1.75 and the Ask is $2.85. Now the difference between the bid and ask price is money that is just flushed down the toilet. In this case it’s $2.85 – 1.75 so $1.10 or $110 we would be giving away since it is 100 shares.
Now in looking at Amazon we see there are over 20M shares traded. And looking at the 110 Put option we see the Bid-Ask Spread is just 2 penny’s wide! So we are only giving up $2 when placing the trade.
Bottom line, you will only be able to close or roll positions at a very unfavorable price if the options in the underlying stock you are trading are illiquid.
We need to target only trades with high options volume and narrow bid-ask spreads so that we are not giving away free money.
Mistake #3 – Too Many Underlying Positions
It’s hard enough to do the research and pick the right stocks. You want to look at the technicals and fundamentals as well the earnings and conference call reports. Even the news around the stock. Sure it technically should all be built into the stock price already.
Point is it takes some time to learn and understand about the companies.
However, going back to the previous mistake, we can immediately eliminate stocks that are illiquid.
I like to have a list of stocks in different industries that are liquid that I like to trade. Then I decide if I think they are undervalued (being the stock price is too low), overvalued (with the price too high) or fairly valued.
I started with just 10 stocks. Then I got to know 20 and then about 30. That’s it. That is plenty of opportunity if you have between 20-and 30 stocks that you watch. At any time you may only have trades on in about 10 or so because the IV is good or they are under or overvalued.
I use bullish strategies that will make money when the stock price moves up for the undervalued stocks. And vice versa bearish strategies for stocks I believe will move down.
Mistake #4 – Trading Too Big
No more than 5% in any one position. I’ve heard it over and over. Have I listened and followed directions? Or did I have to learn the hard way?
Are you guys going to take my word for it? Probably not. Will you learn from it? I hope so.
Trading too big can be both a mental and financial challenge. It’s mental in the sense that it’s sometimes are to have the emotional control to handle large losses and it can be financially challenging because if you don’t have adequate capital to back up your trades, you will end up taking on too much risk with your investment dollars.
Always know where you will (P&L wise in your portfolio) be should an unfortunate catastrophic event occur and the market drops 30%. We never know when there will be a war or political event or even a pandemic. Hopefully not anytime soon. Every few years something happens that causes the market to drop significantly.
Even if we have uncorrelated positions. When an event happens everything suddenly becomes correlated and all your positions go down.
We have to be able to stay in the game by not over-leveraging. These are the times when we want to have cash available to invest while everyone else is getting out.
I recommend always having about 50% of your Buying Power available when the market is average or above the historical average. Since we are trading options, we are already using leverage so we can outperform the market and stocks using much less capital. So there is really no reason to use more than 50% of your buying power.
Beginners often have a little success and see the big gains and the potential and become greedy. They often don’t realize that they are going too big until it is too late and something happens and they lose everything.
That said, if the market has already been hit with a 20 or 30% downside loss then we may be safe having 70 or 80% on at that time with more positions leaning long.
On the other hand if we are at all time market highs already then I like to stay fairly small. If we are not able to sleep at night because we are worried about our options trading account, then we are likely trading too big.
Only when we are comfortable with the daily fluctuations and know that we can withstand any downturn, can we make correct decisions based on probabilities in our favor. It’s when we get too big for our britches and feel like we are invincible that we make mistakes.
Mistake #5 – Not Understanding Implied Volatility
Understanding implied volatility is important when it comes to option trading. Implied Volatility is an expectation of where the stock might move in the future. Depending on how high the implied volatility is it will cause option pricing to increase or decrease to compensate for the volatility.
When implied volatility is high then option premiums are high. And vice versa when IV is low the option premiums are lower as well. So if we are selling options, which is what we want to be doing most of the time we want to do this in high IV so that we collect more in option premium.
So stock Volatility is a measure of how much a stock’s value fluctuates up and down.
If the black line above is stock A then you can see that it has very little volatility and stays in the 100 range. The frequency and magnitude of its moves are very small.
Stock B in the Blue has much higher volatility and makes bigger moves even though it ends up at the same place, $100.
Mistake #6 – Using The Wrong Option Strategies
We’ve talked about this in previous videos. For the most part we want to be option sellers collecting premiums with a high POP probability of profit as opposed to buying options. We want to do this when IV is high so we collect good premiums.
By selling we can have a 70/80 or even 90% chance of winning depending on the strikes we choose. Whereas buying options is like gambling throwing your money away for the most part for only a 20 or 30% of winning.
You can very confidently make a good percentage return on your portfolio when sticking to the one consistent strategy of selling options.
It really takes the gambling aspect out of trading and puts you on the side of being more of the Casino owner collecting the premiums. Or the Insurance company collecting premiums month after month as opposed to the person paying the premiums.
We do want to be on the winning side right?
So we sell options with high IV and use strategies like selling Puts, Calls, Strangles, and Iron Condors.
So do we ever buy options?
The one time that I like to buy options is when IV is low and I find a stock that has been hit and is at annual lows. If I have done my research and am confident that in the next 12 months the stock will be much higher I will use one of my favorite strategies.
I will buy a LEAPS option at least a year and usually closer to 2 years out from expiration. If you are not familiar I’ll put a link down below to a video explaining the LEAPS option. It’s a great way to control 100 shares of stock for less than ½ the cost of buying the stock out right. It also reduces risks over just buying the stock outright.
You can also sell a call against your LEAPS option and collect passive income as well.
Mistake #7 – Buying High And Sell Low – Cut Losses & Let Your Winners Run
What do people do when there is a hot stock that is skyrocketing up? Maybe it’s a little volatile. Maybe a stock like NVidia which is known as the most pure AI Artificial Intelligence play right now.
They Buy into the hype and they buy right at the top of the market.
Then the price falls and panic sets in. And they think to themselves. Man, I better get out this thing it’s dropping like a rock.
So in they end they end up buying at the highs and selling at lows. Hmm….I thought it was supposed to be the other way around.
Guys it is. We need to sell options at highs and buy to close when they are lows.
So how do we do that?
Like discussed before we have a plan and track the liquid stocks we want to discuss. We then place bullish trades in undervalued stocks we think will go up and bearish trades in stocks we think will go down in price.
We can use GTC Good Till Cancelled orders to buy and sell at the prices we want.
Let me know in the comments below if you’d like to see a video on GTC’s.
We also let our winners ride and cut our losses short. This may seem counterintuitive.
There seems to be a trend to stick with losing trades and cut winners at 30 or 50% profit. Don’t get me wrong, any profit is good. However if we are taking 100% losses and then 50% wins we aren’t going to do very well.
So we want to cut our losses short.
Too often, in the beginning, when I was making this mistake, I would be on the losing side of a trade, and I would wait and hope and hope that the trade would come back. And I’d end up losing more.
Well if you liked it at $120, you should like it a lot more at $105.
Yeah, but I’ll like it even less at $95.
What I found out was that if I set a limit in the beginning of how much I am willing to lose before cutting, I am much better off. If I miss on a trade, so be it. There are many more that I will win on and I don’t want to lose too much on any one trade.
Now on the other side when you are in a winning trade you don’t want to sell way too early. Countless times I’ve been in a winning trade and closed at 50% when I could have made 100 or 200% profit. Again GTC orders can help with this by locking in gains and still letting the winners run.
So bottom line we are trading options to make as much money as possible. We do that by cutting losses at our limit quickly and letting winners run.
Mistake #8 – Not Tracking Your Trades
Remember step #1. Having a plan. Well we not only need to have a plan but we need to track our plan so that we can measure the results and make changes when necessary.
I noticed after I began really tracking my trades that I often wasn’t even aware of the results. I’d get wrapped up in it and would overlook losses if I thought off the top of my head “hey I made a good trade, it’s just a little now. It’ll come back soon.
Then I noticed when I started tracking, hey this happened last month too! That’s kinda weird. Consecutive month losses.
It works the other way too. Sometimes you don’t even realize that whenever you trade a certain underlying, for whatever reason it’s always a winner every month.
Knowing that, I will look for opportune times to put that trade on. Some trades I will almost always have on.
Some people like to physically write their trades down in a notebook. I like to use a simple spreadsheet on my computer. It really doesn’t matter which one you use.
I write down my entry plan as well as my exit plan on one spreadsheet. I have each underlying listed, P&L open and P&L YTD. Why I put the trade on and when I will close it out and exit.
After exiting the position I can see if I accomplished my profit goal. I make notes why or why not and document exactly what happened.
Then I clearly make a decision of whether or not I want to trade that position again and under what circumstances. I can check my spreadsheet prior to placing the trade. Without the spreadsheet there’s probably no way that I would know.
Alright guys, the question of the day. What option trading mistakes have you made? Please let me know and share in the comments below. This is how we all learn and succeed together.
———————————————————————————–
I’ve put a link down below for the FREE Options Workshop. Be sure to grab that.
Remember to hit like and subscribe.
Thanks for watching please share this video with a friend and see you in the next one!