Options trading is an entirely different animal as compared to standard stock market investing. Let’s think for a moment about the conventional wisdom that is dispensed concerning stock market investing. The general idea is to buy and hold, keeping your investments for a very long time. You’re expected to keep your investments until retirement. People do various strategies such as rebalancing their portfolio to match their goals, diversification, and dollar-cost averaging.

Options trading is a different way of looking at things. First of all, even if you are a day trader or engaging in activities like swing trading, the general goal, when it comes to stocks, is to buy when the price is at a relatively low point, and then sell at a high price. In reality, the day trader, the swing trader, and the buy-and-hold investor are no different. Buy-and-hold investors think that they are unique and above everyone else, they are in reality just trying to make money off the stock market too. The only real difference, unless you are a dividend investor, is the time frame involved. So, your buy-and-hold investor is going to hold the stocks for 25 years, and then they are going to start cashing them out for money. A swing trader makes money in the here and now.

So, in that sense of options trading is more like swing trading. And, in many cases, you’re looking for the same price swings that the swing trader seeks. But as we’ve seen, options allow many strategies that are not available for any type of stock market investor. I suppose that in theory, you could buy vast numbers of shares of stock and try to set up similar arrangements, but it just wouldn’t work. And besides that, even if it did it would require an enormous amount of capital.

The point of this discussion is just to lay out the groundwork and acknowledged that most of us come to options with a completely different mindset. So does take some getting used to and many beginning options traders are going to make mistakes. That’s just the nature of the market because it’s so different than what people are used to.

We are going to see some of the top mistakes are made by beginning options traders. There isn’t a comprehensive list, I picked out the ones that I’ve noticed most people make the mistake of doing. 

Going Into A Trade Too Big 

One of the mistakes that people make when they start options trading is making their positions too big. Since our options don’t cost all that much relative to the price for stocks, people aren’t used to trading in small amounts. Even people who are not rich or anything thinking terms of the stock price and how much 100 shares with the cost. This can set up people for trouble. The temptation is going to be there to move on a large number of contracts when you start doing your trades, if you have the capital to purchase or sell them. This can get people into trouble. It’s not the dollar amount that’s a concern. Still, it could get you in a position where you’re not ready to act as quickly as you might need to depend on the situation. So, if you find trade and decide to sell 20 contracts, if the trade goes south trying to buyback does 20 contracts might be problematic. Or you might end up buying a bunch of call options and have trouble getting out of them on the same day. It’s better to have a few different small positions with the options than it is to have multiple positions when they are a large number. Remember that options prices move fast. You don’t want to over-leverage your trades and be in a position where you can’t find a buyer to pick up all 10 or 20 contracts. 

Not Paying Attention To Expiration 

This is probably one of the most common mistakes made by beginning traders. The expiration date is one of the most important factors that should be considered as you enter your trades. And once you’ve entered a trade, you need to have the expiration date of the options tattooed on your forehead. This is something that is not amenable to being ignored. First of all, choosing the expiration date when entering the position is just as important as picking the strike price of the option. But one of the things that beginners do is to focus too much on the price of the option and the price-setting for the strike. The cost of the option and the strike price are essential, the expiration date is essential as well.

Unfortunately, far too many beginning traders ignore the expiration date when their trades are not working out. And so, they end up just letting the option expires. Of course, when that happens if it’s out of the money, you are totally out of luck. It’s just going to be at 100% loss. So, we need to be paying attention to expiration dates before we enter the trade, and we also need to pay attention expiration dates when we are managing the trade. 

Buying Cheap Options 

There is a saying that says you get what you pay for. There are reasons to buy out of the money options sometimes, but you shouldn’t go too far out of the money. Unfortunately, many beginning traders are tempted to go far out of the money for the sake of buying a low-priced option. The problem with these options is that even though out of the money options can make profits. If they’re too far out of the money, they only aren’t going to see any action. So, there’s no sense buying a cheap option just because you can pick it up for $25. You don’t want to be sinking your money into options where a massive price move would be necessary to earn any profits. It’s fine to buy options that are near at the money. Options that are close to being in the money can be very profitable even though they are out of the money. So, if you’re looking to save a little bit of money when starting your investing, that is always something to consider. But to make profits, the basic rule is there has to be some reasonable chance that’s the stock prices going to move enough, to make the option you purchase going the money. 

Failing To Close When Selling Options 

If you want to remember just one thing from our discussion about selling options, whether it’s selling put credit spreads or naked puts, you should keep in mind that it’s always possible to exit the trade. The way that you exit the trade when you sell to open is you buy to close. You want to be careful about doing this because it’s too easy to give in to your emotions and panic and prematurely exit a trade. However, you need to be aware at all times of the possibility of needing to close the trade. Riding out an option to expiration is a foolish move unless it’s apparent that it’s going to expire out of the money.

As a part of this problem, new options traders often come to the market and they focus on hope as a strategy. When it comes to investing, hope is not a strategy. Hope is something that belongs to a casino playing slot machine games. When you’re training options, you should make as rational a decision as you can make it given the circumstances. So, when the expiration date is closing and it’s clear that the trade is not going to be profitable, don’t give in to the temptation to say of waiting around for a reversal in direction. When you say something like that to yourself that opens up the temptation to stay in the trade far too long. At some point, you might not be able to recover at all. So, what you don’t want to do, and this is actual buying and selling, is hoping that there’s going to be a turnaround and waiting to see what happens.

For those who are buying options to open their positions, this is the worst of all possible strategies. Remember that when you buy to open a position, time decay is working against you at all times. So, unless the stock is moving in a right direction, there isn’t a reason to hold the option. For sellers, time decay works in your favor. But there can be situations when it’s just smart to get out of the trade. Let’s look at a couple of examples.

If you sell to open an iron condor, and for some reason, the stock has a breakout to one direction or the other, it’s better to get out of the iron Condor now. We aren’t talking about a one or two-dollar change. If the stock goes in such a direction that one of your options goes in the money by a small amount, that type of trade is worth waiting out to see what happens. But if there is a big break to the upside or the downside, it would be foolish to stay in the trade. For one thing, there would be at risk of assignment, but the most likely situation is that you’re just going to lose the maximum amount of money. But if you have a good strategy and only getting involved with options that have a high level of open interest, almost no matter what the situation is, you should be able to buy and sell that option pretty quickly.

The other obvious example is if you were selling a put credit spread already naked put, and you noticed that the share price is declining right towards your strike price. You don’t have to panic right away because remember that for exercising the option to be worthwhile, the share price has to move enough, so that not only does the option go in the money, but the price move also accounts for the money that was paid for the premium to buy the contract. So, if you have a strike price of $100 and someone paid two dollars to buy the option, if the share price is $99, they are going to exercise the option. Even if it drops to $98, they still might not exercise the option, unless there was some factor to indicate that the stock was about to turn around so they can sell it at a profit. But that’s an unlikely scenario. It’s only when it starts going strong and that there’s a problem. 

Trading Illiquid Options 

This is such an important issue I will repeat it. Liquidity is essential when trading options. What liquidity means is the ability to buy and sell financial security quickly and turn it into cash. It’s not enough to like the company in order to start trading options on the company. If the open interest for an option is only 8, 10, or even 45, that is going to throw up obstacles when you need to move to get rid of an option fast. The largest companies generally have liquid options, but you should always check. Index funds also have liquid options. Avoid any companies that have small open interests. The only way that you would trade when the open interest with small is if the probability of losing out on the trade is minuscule. So, besides the strike price, share price, an expiration date, you need to be looking closely at open interest. You don’t want to get in a situation where you cannot exit a position.