In Continuation with Previous Post Todays post we will discuss Mistakes to avoid when writing/shorting Options
- Trading way above your Limit
Over-positioning is the biggest mistake new option sellers make.
This is how it works: New traders sell a few options, see them decay and get excited thinking they have found the Holy Grail of making “sure shot money”. Going by Intital Beginners Luck Traders proceed selling far too many options relative to their account size and end up with either too many options for their account.This puts the whole trading account at greater risk of taking losses. Option selling works but you have to understand and respect the leverage. Remember you are supposed to be right most of the time in premium selling but at some point you will take a loss and you can’t let that loss wipe you out.
Option selling can sometimes be detrimental to active traders. Traders want to (and sometimes think they have to) trade every day. Option selling is more of a passive activity that requires mostly time and patience. This puts the strategy at odds with active traders that like a lot of action.
- Selling too close to the money
Never ever write an ITM position or ATM options seeing High Premium, as DELTA of options is between 1 to .5 and risk of taking loses is very high, Always try to Write OTM options with proper risk management. Just select options that are at least 50% out of the money and preferably 75% to 100% out of the money. This means looking for markets with a little more volatility and being willing to write them further out in time. I will cover more on this in my next article.
- No exit plan
Most of traders get excited about entering a trade and don’t bother to think about what they will do if things don’t go as planned. When they do get a trade that isn’t working, they can often experience altered judgment or, worse, panic and overreact regardless of where the market is.
Always follow 200% rule when you are writing Options.
Basically, if the option sold doubles in value from the point at which you sold it, get out. True, there are times these options will ultimately expire worthless, but it is simply not worth the risk.
Of course, it is irresponsible to assume one rule is right for every position or that it is optimal for all positions to be placed with a pre-defined strategy beforehand. If a position is moving against you, you should be prepared for action long before that option doubles in value. Managing risk on your option selling positions should be more like steering a large ship than a Formula One race car.
The point is there are several ways to manage your risk. Some writers use hard stops while others roll out positions to further out strikes and contracts. The important thing is that you have an exit plan in place. That way, when the market or your option reaches a certain level, you know exactly what to do. You are not reacting emotionally.