We talk a lot about what traders should do staying disciplined as they wade through the often choppy waters of the market. Today we look at the opposite: which traders should not do. We break out our list of Top 5 best ways to lose money trading options.
Renowned options trading subreddit Wall Street Bets is known to have perfected this art, so alongside each of these alerts will be a cautionary tale from Reddit’s favorite exchange community. If you are easily offended soul-destroying option lossesthis is your trigger warning: turn back now.
Still here? Good. Let’s start with a simple way to lose money trading options:
5. Buying options that are too far out of the money
This is common among novice options traders. It’s going ok:
- You believe that stock XYZ is going up.
- You buy a call option.
- The stock costs $100 per share, but you buy the $150 strike price with a delta of 0.0067.
- Over the week, the stock is up 5% to $105 a share! What again!
- Wait a minute… Why aren’t my options increasing?
answers: You bought options that have a very low probability of winning. Yes, you were right about the direction of stock movement, but it wasn’t moving fast enough to increase the chances of your option expiring in-the-money by your chosen expiration date!
In summary: Theta ate your options
To avoid this error, familiarize yourself with Delta. Delta is options Greek, measuring your option’s sensitivity to dollar movements of the underlying stock. But many also view delta as a proxy for the probability of an option expiring in-the-money. That 0.0067 delta option you bought? You can think of it like this, there is a 0.67% chance of ITM expiring.
translation: You can also buy a scratch card if you are looking for those odds.
Speaking of expiration dates, theta decay, and buying low-quality options, here’s another common technique used by options traders to lose Money:
4. Purchase options that are about to expire
This story is similar to the last one.
- You believe that stock XYZ is going up.
- You buy a call option.
- The option expires tomorrow.
- As the day progresses, the stock turns and ends the day flat.
- But wait… the stock hasn’t fallen between buying the option and now, so Why is my option constantly losing value?
answers: Long options such as calls and puts are subject to what is known as theta decay. Theta, like delta, is a Greek option. However, instead of measuring sensitivity to dollar movements in a stock (like Delta does), Theta measures options sensitivity Time. The closer your option is to expiration and the further out of the money your option is, the more sensitive your option becomes.
In summary: You got theta again! At least the premium collector who sold you this option is happy.
Scroll to Next
To avoid this error, familiarize yourself with the theta decay curve.
It’s not really a waste of time So bad if your option expires more than 60 days. But over time, the decay begins to accelerate, reaching the maximum rate around the 14-day mark. When you trade an option with fewer than 14 days until expiration, that’s fine – but you better have a plan. Jon Najarian, co-founder of Market Rebellion, calls these short-term options trades “the deep end of the pool.”
translation: If you’re new here, this is an area you might want to avoid…unless you have the guidance of a licensed professional.
Would you like to trade short-term options under the guidance of a licensed CMT? To attempt rebel week. Get two easy-to-follow, momentum-driven trading ideas designed to capture technical breakouts and breakdowns – delivered to your inbox every week.
All right, you may have traded a few options already. You know the basics – don’t go too far OTM, be careful with short-term options… But here’s another way options traders can trap themselves in a low-quality position:
3. Illiquid options trading
This is especially common when taking multi-leg option trades in low-volume stocks. It’s going ok:
- Stock XYZ isn’t getting much action – you think it’s going to trade flat for a while.
- They sell a short iron condor – a four-legged spread.
- When you enter the trade, you find that the bid/ask is several dollars wide.
- They have trouble getting filled at mid-price, so they have to continually lower your maximum balance to get filled.
- They eventually get filled at an unfavorable price and start trading with a “paper loss”.
- For the week, the stock remains mostly flat — that’s what you wanted! But now you have to deal with the same problem again: getting filled at a reasonable price when you try to close the trade.
- You are faced with two options:
- Wait and hope your order gets filled before the stock leaves your profitability zone.
- Overpay to close your spread and sacrifice some or all of the profit you’ve made.
- Well, that’s frustrating. How can I avoid this problem?
answers: To get familiar with open interest and volume. These are two important liquidity metrics that every options trader should understand – even if you don’t trade spreads. The volume indicates the total number of options contracts bought and sold on that day. Open Interest indicates the total number of active options contracts.
In summary: It’s not just about that being correctIt’s about Choosing the right tool for work.
translation: When volume and open interest are low or close to zero, so is your probability of getting a good fill. Remember that the market maker has to match the highest bid with the lowest bid – that is the middle price.
It is important to look for tight bid/ask spreads whenever possible. If the spread is particularly large, that’s a good sign that you’re going to have trouble filling your order reliably near the mid-price.
There’s not really a great “picture” of someone frustratingly trying to fill up on a low volume option, so here’s an example of what a low liquidity options chain looks like instead.
So far, it has only been about avoidance inferior options. The next big don’t involves avoiding a low quality trade style.
Made famous by options trading subreddit Wall Street Bets, YOLOing means you allocate your entire portfolio to one trade – despite the potential reward, the high risk means that the YOLO (You Only Live Once) trade is very, very not is recommended.
- You are secure this stock XYZ is going up today.
- So confident that you’re betting your entire portfolio on this result.
- Surprise: it doesn’t. You are wrong. And because you’ve used your entire portfolio on that bet, the damage is magnified.
- How can I make sure this never happens again?!
answers: Start developing your risk management skills. Option leverage is an incredibly versatile tool that can help traders take risks fewer — allow traders to risk only a fraction of the value of 100 shares in exchange for leverage worth up to 100 shares. But with great power comes great responsibility – and it is your responsibility not to abuse option leverage with high-risk scenarios.
translation: You may be a great trader, but nobody is perfect. When you YOLO your entire account trade by trade, a single mistake is enough to undo years of hard work.
In summary: Don’t end up like this guy:
YOLO: ✔️Short term: ✔️OTM: ✔️— That’s literally ¾ of the things we’ve covered so far!
Okay, so far these traders have made some serious options trading mistakes. But they all avoided the cardinal rule. They all avoided the worst mistake on this list:
1. Betting Money You Don’t Have: Naked Options & Margin
Yes. These traders lost a lot of money. Yeah, they’re probably all pretty sad about it. But at least they only lost to zero. Here’s a scenario that’s even worse:
- Your brokerage allows you to use naked options strategies, holding some collateral and covering the rest with margin.
- They decide to ignore this glaring risk and instead try to collect the premium from a short straddle before the stock XYZ win event.
- Profits come with high-cost options – and high-volatility moves.
- In a short straddle, your goal is for a stock not to move.
- Unfortunately, the stock moves — a lot, resulting in a greater overnight loss than the value of your portfolio.
- The loss triggers a margin call, your broker liquidates your portfolio, and you’re left with a negative value — a debt you must now pay in exchange for your options trading hubris.
- I just wanted to collect a bonus! Is there a way to sell options without taking infinite risk?
answers: Yes, there are many strategies to sell options with defined risk. Market Rebellion has entire services designed to do just that! Strategies like credit spreads, short iron condors, short iron butterflies, and covered calls are just a few ways you can sell options without the trade potentially going negative.
translation: By selling an option versus Another option, you define your maximum risk.
In summary: As with YOLOing, one wrong move can undo years of hard work. Unlike YOLOing, this strategy can bankrupt you. Naked options: never, never, never, never.
Unless you want to end up like these guys:
The final result: Viewing images of massive losses is fun and games until it happens to you. By avoiding these five critical options trading mistakes, it is possible to have a long, successful options trading career.