How to Avoid the 3 Biggest Mistakes New Option Sellers Make
The latest round of stock market turmoil has many former “traditional” investors finally venturing outside the box of “buy and hold” in search of alternative investments. Dipping your toe into the Option Selling game can be a good way to start enjoying the benefits of premium collecting without worrying about stock market direction anymore. This is especially true if your premium is coming from the higher premium, lower margin commodities options.
However, commodities are a different ballgame from stocks. Beginners tend to make common mistakes that can end up costing them a “tuition” to learn the ropes of this new asset class. To help you avoid these (and cut down or eliminate your entry fee), we’ve compiled the top three beginner mistakes and explained how you can avoid them.
Top 3 Beginners Mistakes for Option Sellers
#1 Over Positioning
New Option Sellers often make the mistake of taking too many positions, either in one market or in their overall account.
Stock traders have grown up with the concept of having all of their money “working for them” in the market.
They duplicate this philosophy when they transition to commodities. But they’re making a mistake. Commodities options offer high premiums and low margins because of built in leverage. While this can provide bigger returns, it also means care must be taken to avoid downside risk and fluctuations in margin requirements.
#2 Selling too Close to the Money
Stock Option Sellers are used to selling one or two strike prices out of the money. But in commodities, you don’t have to do that. In this asset class, there are strikes available, 20, 30, 50 sometimes even 100% out of the money. Stock option sellers exploring selling commodities options often make the mistake of selling close to the money, short term options. Their reasoning is that they will get the fastest time decay this way. But one hiccup in the underlying and their options are in the money – a place you want to avoid.
#3 Not Having an Exit Plan
This may sound self evident. But you would be surprised to see how many otherwise disciplined investors jump into commodities option selling without a plan. Selling the option and then “watching it” is not a plan. Sure, most of the time it expires quietly. But when they do get one moving against them, it becomes a “what do I do now” situation. That often leads to emotional trading – which usually leads to a loss bigger than it needed to be.
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Michael Gross is Director of Research at OptionSellers.com and co-author of McGraw-Hills The Complete Guide to Option Selling, 3rd Edition. To learn more about managed option selling portfolios at OptionSellers.com, visit https://www.optionsellers.com/investors-discovery-kit/