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    The Four Biggest Mistakes in Option Trading
    The Four Biggest Mistakes in Option Trading
    The Four Biggest Mistakes in Option Trading
    Ebook108 pages1 hour

    The Four Biggest Mistakes in Option Trading

    By Jay Kaeppel

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    About this ebook

    With over 50,000 copies in print for the first edition, Kaeppel's insight has undoubtedly made its mark in the options world. Now, he strikes again with an updated and more comprehensive look at those pesky mistakes that traders continue to make in trading options. In easy-to-understand terms, he systematically breaks down each problem and offers concrete and practical solutions to overcome it in the future.

    There are big profits to be made in options trading. By avoiding the four most common and most costly mistakes the majority of traders make, you'll be set to win big. System and software developer Jay Kaeppel helps you thoroughly understand each mistake before showing you how to avoid them in future trades.

    In this new, color edition, you'll find:

    • More in-depth analysis of the four biggest mistakes including volatility calculations, risk/reward relationships, calendar spreads, etc.
    • More real world examples with varying scenarios updated to reflect today's market
    • More graphs and tables to better illustrate Kaeppel's concepts
    • More detailed discussion on the nature of options trading and how to create a consistently winning strategy

    Concise and to-the-point, here's an action plan you can read and put into place immediately to become a more profitable trader.

    LanguageEnglish
    PublisherWiley
    Release dateOct 15, 2012
    ISBN9781118538371
    The Four Biggest Mistakes in Option Trading

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    • 4/5
      Easy to follow and well geared towards those new to the trade.

      1 person found this helpful

    • 5/5
      The book is clear and gives good analysis of the option trader's mistakes. It really helped me in searching for better trades

      1 person found this helpful

    Book preview

    The Four Biggest Mistakes in Option Trading - Jay Kaeppel

    INTRODUCTION

    Options offer traders and investors a number of unique and outstanding opportunities that are not available to those who trade only the underlying stock or futures contracts. A bullish speculator can choose to buy a call option for a fraction of the cost of purchasing the underlying security. Likewise, a bearish speculator can buy a put option. In either case, the speculator enjoys the potential for unlimited profits with limited risk. Other traders may employ strategies that offer an extremely high probability of profit. Many opportunities exist for well-educated traders to craft option positions that make a profit if the underlying security stays within a particular price range, or if it remains above or below a given price. This ability to make money in neutral market situations is something that is available only to option traders. In addition, investors can use options to hedge existing stock or futures positions. Through the astute use of options, investors can mitigate or, in certain cases, virtually eliminate the risk of loss for a position that they hold in a given stock or futures contract. Investors can also use option-hedging strategies to generate additional income from an existing portfolio of stocks.

    Yet, despite all of these potential benefits, it is commonly estimated that 90% of option traders lose money in the long run. This staggering figure raises several extremely relevant questions:

    1. What is it about option trading that causes so many people to fail?

    2. Is there a way to avoid the apparently huge pitfalls that claim so many traders?

    3. If the failure rate is so high, why does anybody bother trading options in the first place?

    After listening to a multitude of traders talk about their ideas on trading options over the years, it is interesting to note that there are several common themes running through many of these discussions. This raises an interesting question. If 90% of option traders lose money, and a lot of traders subscribe to the same ideas, can one gain an edge by avoiding the common approaches used by these traders?

    In order to attempt to answer this question, I systematically tested the option trading approaches most commonly mentioned by traders—especially novice traders—using computer simulations.

    As I will detail in the following sections, there are several common pitfalls that the majority of option traders fall into that cause them to lose money in the long run. As we often find to be the case in the realm of investing, whenever the crowd migrates to an idea or set of ideas, it usually pays off handsomely (in the long run) to go the other way and simply avoid whatever the crowd is doing. The good news is that by isolating the mistakes most commonly made by option traders, learning why they are so common, why they cause losses in the long run, and how they can be avoided in the future, you take a major step toward becoming a consistently profitable option trader.

    There are good trading ideas and bad trading ideas. One of the best ways to find the good ideas is to first eliminate the bad ones. This is what I will attempt to accomplish in the following discussions where we will focus on the four biggest (and most common) mistakes made by the majority of option traders. So consider this the how not to portion of your option trading education.

    For each of the following four biggest mistakes in option trading, I will first discuss what the mistake is. It is important to have a clear understanding of each error in order to be able to recognize in the future when you might be about to fall into a potential problem situation. I will then explain why it is so common for traders to make this mistake and why it causes traders to lose money in the long run. The idea here is to help you understand the reasons behind why a seemingly enticing idea can lead to your downfall in the long run. But, if you can learn how to avoid making these mistakes, you will stop falling victim to the siren song of tried and failed ideas. Finally, I will detail what needs to be done in order to avoid each of the most common mistakes. The goal here is to teach you to think independently of the the crowd and to teach you how to achieve the success that most option traders can only dream about.

    One word of warning: a lot of traders may not enjoy reading these sections for the simple reason that we are about to de-bunk several ideas that many hold near and dear. Much of what you are about to read details the way that the majority of option traders trade. Yet, given the fact that most uneducated option traders lose money, it is important to read these sections with an open mind. Most often when someone attacks an idea that you believe to be true, or which conventional wisdom has convinced you is true, the first reaction is to become defensive and to try to defend your reasons for believing the idea in the first place. It is impossible to overemphasize the importance of reading the following text with an open mind if you want to trade options profitably in the long run. This is especially true given the following paradox: in most cases, the very ideas that lure traders into the options market in the first place are the same ideas that cause them, in the long run, to lose their time and money.

    Mistake #1

    Relying Solely on Market Timing To Trade Options

    WHY TRADERS MAKE MISTAKE #1

    Far too many first-time option traders view options as nothing more than a tool for leveraging their market timing decisions. That is, rather than buying or selling short a particular stock or futures contract, they feel that they can buy a call or put option and:

    Commit a great deal less capital than they would to buy the underlying security itself, and,

    Obtain a great deal more leverage than they would if they simply bought the underlying security.

    And, in fact, it is possible to attain these benefits via option trading. By putting a relatively small sum of money into an option position, it

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