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