Trading options for the first time feels a little bit like the first day in a new school.
You don’t know anybody, you don’t have anyone to talk to, and you don’t have a clue of how you are going to survive the year.
Similarly, when you are new to trading options you don’t really know where to start, where to get tips on potential targets, or which strategies will work the best for you.
In this article, I’ll shift your perspective a bit to help you identify which mistakes you should avoid if you are new to trading options, rather than focusing on things you should do or strategies you should try.
Mistake #1: The Single Basket Portfolio
There’s a timeless saying in the investment world you have probably heard of: don’t put all your eggs in one basket.
As simple as it may sound, if you are trading options for the first time you might feel tempted to put all your money into a “great idea” you have stumbled on.
This is perhaps the biggest and most expensive mistake you can make as it exposes you to losing a significant portion of your capital, especially if you are considering taking on leverage to build up your position.
As a rule of thumb, no position should be bigger than 5% of your portfolio, no matter how confident you, your friends, family, or spouse feel about it. Remember, you are new to this, it takes time to get the hang of it and that is entirely normal.
Do yourself a favor a don’t fall for the lottery ticket trap. Diversify your positions as much as possible, especially if you are just starting.
Mistake #2: The Big Winner
Financial news have somehow created a standardized goal for all the investment community: beating the annual return of the S&P 500.
Most traders are fixated with this idea of beating the market and they frequently intend to do so by looking for the next Apple or Netflix.
The truth is that most successful traders achieve this goal not by looking for the next big winner, but by making a wide number of trades using different strategies and approaches each month to achieve a 1% to 2% monthly return.
That may not seem much at first glance, but compounded annually it adds up!
Failing to understand the power of compounding small monthly returns will probably put you in a position of frustration as you’ll be constantly looking for the next big winner to boost your returns.
Mistake #3: Not Knowing Your Greeks
The “Greeks” are risk-assessment metrics employed to understand how an option might behave based on different variables and perspectives.
The most popular greeks include:
- Delta (Δ) – measures the price sensitivity of the option.
- Vega (v) – measures how the price of an option may react to a change in the implied volatility of the underlying security.
- Theta (Θ) – measures how the price of the option fluctuates as the expiration date approaches.
These greeks will help you in understanding how your options might react to certain situations and it is essential that you measure, understand, and analyze them before you enter a position.
If this is your first day at the options trading school this article is a useful guide to know what you shouldn’t do. Consider this an insider’s tip from someone who already knows (to some extent) how the school works!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.