By: Steve Smith
As investors await today’s FOMC meeting and the looming decision as to whether tariffs will be escalated on Sunday, most normal people are winding down the year and finishing up their holiday shopping, I thought this would be a good time to review some of the common mistakes traders make when using options.
As shoppers have become increasingly savvy in finding online bargains and discounts, we see similar behavior spilling into other aspects of their lives. This includes investment advice and stocks they seek. But sometimes it’s better to pay up to get a little better quality. This is particularly true with options. Which brings us to the first of our rookie mistakes.
Buying “Lottery” Tickets
Too often, new traders opt for buying way out-of-the-money options as they are attracted by their low notional dollar amount. They perceive them as a “bargain” and a good way to gain the leverage of options. But, the low cost doesn’t mean they are “cheap.” In fact, out-of-the-money options usually have a higher implied volatility than those closer to the money (near the underlying stock price) and are, therefore “expensive’ in relative terms.
Out-of-the-money options also come with a much lower delta, meaning it will take a much larger price move in the underlying shares to cause an increase in the value of the option. The probability they will deliver a profit diminishes the further out-of-the-money you go. Remember, something like 80% of all options expire worthless.
Once in a while, it’s OK to make a calculated risky bet as there might be a takeover or news event that will catapult a stock higher. But for your… Continue reading at StockNews.com
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.
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