With the market going up, and people getting more bullish, there
will be an increasingly larger number of people buying call options
on those stocks they expect to go up even further.
However, there will also be an increasingly larger number of people
losing money on those very same call options designed to make money
as the market rises.
It's sad, but true.
There's nothing worse than buying an option (call or put), and
seeing the market ultimately move in the direction you expected,
but still losing money on your option nonetheless.
This is usually the result of some all too often made mistakes.
The good news is that these mistakes can easily be corrected.
I'll outline three key mistakes that options traders make, and then
provide a solution for each one them.
Problem #1) Unrealistic Expectations and Low Probability
I was going to name this first point 'greed'. But it's really just
After losing money in your stocks over the last few weeks, one
might be tempted to swing for the fences and load up on puts in an
effort to try and 'make it all back' in one fell swoop.
They'll go out and buy a bunch of cheap options (so they can buy
more of them), but with deltas so pitifully low that they'd need to
see a gigantic move for those to ever payoff.
Focus in on the options with a delta of at least 60%, and
preferably 70% or higher.
The delta tells you how much your option should move in relation to
the underlying stock.
But the delta is also considered to be a gauge as to what
percentage likelihood there is of the stock reaching that option's
strike price by expiration.
An option with a delta of 75% means there's a high likelihood (a
75% likelihood) that that option will expire in-the-money.
A delta of 20% means there's only a 20% likelihood of that option
finishing in-the-money. And do you really want to load up on a bet
with only a 20% chance of success? I don't.
Problem #2) Not Buying Enough Time
Whether you're expecting a stock to go up or down, we have a
tendency to overestimate the size of the move that could be seen,
and underestimate the amount of time it could take to do it.
With an option, if you run out of time, it's game over. And with
many investors skimping on how much time they buy in their options,
this happens all too often.
However much time you think it'll take for your stock to do
whatever you think it's going to do, add at least one more month to
it and buy the option with at least that much more time.
Plus, the options with more time are almost always the better
value. An option selling for $500 with 2 months of time may seem
cheaper than a $700 option with 4 months of time, but it's not the
For example: $500 divided by 2 months means you're paying $250 for
each month of time that you purchased.
But $700 divided by 4 months means you're paying only $175 for each
month of time. That is the better bargain. And more often than not,
you'll be glad you had that extra time as that can make the
difference between making money on your trade or losing it all.
Problem #3: Trading Options Like Stocks
I'm all for cutting losses and letting your profits run. But with
stocks, your time to let your profits run is unlimited. What I mean
is, if the stock makes a good move and you're expecting more to
come, you can wait a stock out if it starts to consolidate, or
makes a possible retracement, etc. But, ultimately, if the stock
eventually continues its move in your direction, all is good and
the gains will add up.
But options are different since there's limited staying power.
Regardless of your outlook on the stock, even if it's moving for
you, consider getting out of any option once it has only 30 days of
Options, even those that are in-the-money, are comprised of both
intrinsic value and time value. And if your options are
out-of-the-money, they are comprised of only time value. Time
value, of course, is a fleeting asset that's prone to time decay.
And within 30 days to expiration, that time decay accelerates
tremendously, meaning your option would need to appreciate in value
by a certain amount each day just to stay even.
So if your stock is in a consolidation period (or worse, is pulling
back) then your option is losing value. Even if the stock was
standing still, your option is still losing value each day that
There's even a way to see how much your options could potentially
be losing per day just due to time decay. That metric is one of the
'greeks' and it's called Theta. And it will show you how much
premium your option will lose in time value each day.
So options, as they get closer to expiration, lose their staying
power, unlike stocks where the staying power is constant.
So set yourself a rule that you'll jettison your options before you
get into that 30-day time-decay red zone and roll into a new
But don't be afraid to pull a profit and seek out the next
opportunity that looks as promising as the one you just profited
As the saying goes, you'll never go broke pulling a profit.
Follow these three tips to overcome common mistakes in your options
trading and you'll start making money no matter what the market is
You can learn more about different types of option strategies by
downloading our free options booklet: 3 Smart Ways to Make Money
with Options (Two of Which You Probably Never Heard About).
Just click here.
And be sure to check out our
Zacks Options Trader
Disclosure: Officers, directors and/or employees of Zacks
Investment Research may own or have sold short securities and/or
hold long and/or short positions in options that are mentioned in
this material. An affiliated investment advisory firm may own or
have sold short securities and/or hold long and/or short positions
in options that are mentioned in this material.
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