Top 10 Option Trading Mistakes: Watch How to Trade Smarter

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Stock option king

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For example, stock traders will flock to one form of let’s just say, IBM stock, but options traders could have six different expirations and a plethora of strike prices to choose from. More choices, by definition, means the options market will probably not be as liquid as the stock market.

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The risk, however, is in owning the stock – and that risk can be substantial. Although selling the call option does not produce capital risk, it does limit your upside, therefore creating opportunity risk. You risk having to sell the stock upon assignment if the market rises and your call is exercised.

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Short spreads are traditionally constructed to be profitable, even when the underlying price remains the same. Therefore, short call spreads are considered “neutral to bearish” and short put spreads are “neutral to bullish.” This is one key difference between long spreads and short spreads.

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If you sell options, just remind yourself occasionally that you can be assigned early, before the expiration date. Lots of new options traders never think about assignment as a possibility until it happens to them. It can be jarring if you haven 8767 t factored in assignment, especially if you 8767 re running a multi-leg strategy like long or short spreads.

Trading options that are based on indexes can partially shield you from the huge moves that single news items can create for individual stocks. Consider neutral trades on big indexes, and you can minimize the uncertain impact of market news.

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For example, what if you sold a $ option and it 8767 s now worth 75 cents? You wouldn 8767 t sell a 75-cent option to begin with, because it just wouldn 8767 t be worth it. Similarly, you shouldn 8767 t think it 8767 s worth it to squeeze the last few cents out of this trade.

Here 8767 s a good rule of thumb: if you can keep 85% or more of your initial gain from the sale of the option, you should consider buying it back. Otherwise, it 8767 s a virtual certainty. One of these days, a short option will bite you back because you waited too long.

Erika Johansen is a lifelong writer with a Master of Fine Arts from the Iowa Writers Workshop and editorial experience in scholastic publication. She has written articles for various websites.

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