What are they?
It’s been about a month since I started dipping my toes into the wild and frantic world of options trading. So, I thought this would be a good time for me to reflect on some of the more costly lessons I learned.
For starters, you need to know that trading options can be a lot like gambling. You can make a lot of money very quickly and you can lose it just as quickly. We recommend brushing up on options basics here.
#5 No After Hours trading
There’s not much worse than seeing some piece of news break after the market has closed. You to watch helplessly as the price of your stock declines, destroying the value of any calls on that position. Because of this, I try very hard not to get stuck holding short-term positions overnight.
#4 No Trailing Stop Loss Protection
This makes it more difficult to execute an exit strategy to limit any losses. And you need to constantly update your triggers. Part of what makes options so enticing is how fast they can move in either direction. But, because of this, you have to really babysit them to ensure your floor is protected. This can also make it harder to let go of losing positions because the gambler in me wants to let it ride rather than take a small loss and regroup.
#3 Earnings reports are factored into the price of a contract
The contract will lose significant value the moment the report is released. This requires a large movement in the price to make up for that loss. I had tried several times to profit on companies I felt would report strong earnings. Even when the earnings beat the consensus, I still lost half the value of my contract thanks to the drop in Vega, or the option’s value of volatility. The safer move seems to be selling out your position the day before the earnings are released.
#2 Contracts lose value over time
Time is a factor in the pricing of an options contract, represented by the Greek Theta. So when you buy a contract, the movement of the stock has to has to be enough to make up for the constant erosion of value due to time’s relentless march forward. This is not a linear drop either, Theta’s value declines faster as the expiration date is approached.
#1 It Works Until it Doesn’t
Multiple times I had found what initially seemed like a winning strategy that would work five or six trades in a row, then fail miserably on the next. That one failure would be enough to wipe out all or more of the gains made by the previous wins.
If you’d like to hear more about how to lose money trading options, check out Two Bulls in a China Shop as Dan and I detail our painful journey learning about the stock market.
Need more basics? Check out our knowledge center!
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