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Trading & Risk

Common Options Mistakes

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Common Options Mistakes

The path to options proficiency is paved with predictable errors. These are not exotic mistakes; they are the same stumbles that befuddle beginners year after year. Understanding them in advance does not inoculate you against them entirely—experience teaches through repetition and loss—but it can cut years off your learning curve and preserve capital that would otherwise evaporate.

The first and most common error is buying too much premium. A beginner sees an interesting technical setup on a stock and buys an option. The premium is $3 per contract. They feel like they are getting a deal because the stock price is $150, so the option is "cheap" at 2% of the stock's price. What they miss is that the stock needs to move 3 points (2%) just to break even, and they have only 40 days for that move to happen. The option's decay curve means that half the premium will vanish in the first half of the option's lifetime, not evenly distributed. Buying too much premium means betting on a large and rapid move; unless you have strong conviction and a short time horizon, you are fighting against the underlying probability distribution. A better habit: know the option's break-even price before you buy. Is that level reasonable given the stock's recent volatility and your time frame? If the break-even requires a 5% move in a stock that typically moves 2% in the relevant time period, you are overpaying.

The second error is ignoring IV crush. Implied volatility often spikes before major events—earnings announcements, FDA decisions, economic data—and collapses after the event, regardless of which direction the underlying moved. If you buy a call before earnings expecting a 5% move, and earnings come and the stock does move 5%, you should be thrilled. But implied volatility drops sharply; it falls from 60 to 35. Your call's value depends on both the underlying price and IV. The price move helped you; the IV collapse hurt you. In many cases, the IV crush overwhelms the benefit of being right on direction. A trader who bought a call when IV was 60 and tries to sell it after a 5% up move while IV has plummeted to 30 often finds the option has lost value despite the favorable price move. Learning to sell before major events, or to sell the option shortly after if you do hold through, is crucial. The mistake is holding a volatile-vega position through the volatility catalyst.

The third error is position sizing based on the option's price rather than its Greeks. A $2 call that is 30 delta is entirely different from a $2 call that is 5 delta, yet a beginner might buy the same number of contracts of each, thinking "they're both $2, so they're equivalent." A 30-delta call is nearly synthetic-long; a 5-delta call is a lottery ticket. A portfolio full of 5-delta long calls has enormous gamma and enormous theta decay; you are betting on a sharp directional move, and time decay will vaporize your position if the underlying stays calm. If you size both the same way, you will be surprised by the portfolio's actual risk. The solution is to size by Greeks: decide how much delta, theta, and gamma you want, then determine position size accordingly.

The fourth error is trading without an exit plan. The difference between a professional and an amateur is often not the entry; it is the discipline at the exit. A beginner buys a call and watches it. If it goes up 20%, they want to hold for 100%. If it goes down 20%, they want to hold "for a reversal." They have no predetermined level at which they will exit with a loss or take a profit. Options decay relentlessly; if you do not have a plan to exit, you will often exit at the worst moment, holding losers and selling winners too early. A simple rule: before you buy, write down two numbers. (1) The price level at which you will exit with a small profit, say 25% of the option's cost recovered—and actually exit there. (2) The price level at which you will exit with a loss, say 50% of the option's cost lost—and exit there without hesitation. Exit discipline turns losing days into breakeven days and transforms occasional winners into consistent ones.

The fifth error is liquidity traps. An options contract that is thinly traded has a wide bid-ask spread. You might see a "price" of $1.50 quoted, but the bid is $1.20 and the ask is $1.80. When you buy at $1.80, you are paying 50% more than the midpoint. When you sell at $1.20, you are receiving 33% less than the midpoint. A round-trip trade (buy then sell) costs you that spread twice. In liquid options, the spread might be 5 cents on a $2 option (2.5% round-trip cost). In illiquid options, it might be 50 cents (25% round-trip cost). Many beginners buy illiquid options because the strike and expiration look perfect for their thesis, then cannot exit without taking a bath. Check the bid-ask spread and option volume before you commit capital. If an option has fewer than 10 open interest, it is often illiquid, and you should find a more liquid substitute or adjust your strike and expiration to match available liquidity.

These five mistakes are not errors of ignorance; they are errors of omission. You will make some of them. When you do, the sting is instructive. The goal is to make them once—or not at all—and never return.

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