Stock Options Trading – Some Basic Mistakes
Stock options trading can be interesting, challenging and profitable.
It can also be risky – especially if you are a new trader and are not familiar with how the process works. Here are some of the more common mistakes made by inexperienced traders.
One of the most common mistakes is to begin by trading "out of the money" call options. A call option is a contract that allows you to buy a block of a certain stock at a specific "strike price" within a specified period of time.
This is a bullish strategy. It is the kind of contract you would buy if you thought the stock was going to go up in price beyond the strike price.
For example, let’s say ABC stock is trading for $30 today and you have reason to believe it might go to $40 over the next few months. You might buy a call option that would allow you to purchase the stock at $35 within the next two or three months.
You would pay a slight premium for this contract – say it is $1 per share. If the price does not go up as you thought it would you could just let the option expire – and lose the premium.
But if it does go up as you had hoped, you could buy the stock at $35, turn around and sell it for $40, and end up with a net gain of $5 minus the premium of $1.
This is called an "out of the money" option at the time of purchase because the current value ($30) is lower than the strike price.
New option traders tend to like this kind of trade because it is easy to understand and has important similarities with regular stock trading. You hope to buy low and sell high, thereby making a profit.
But many experienced options traders will tell you this kind of trade rarely results in a profit – especially as a longer term strategy. Over the long haul if you restrict yourself to making trades like this you will probably end up losing more than you gain.
The reason is simple: the market rarely performs exactly as you think it will – especially when you add the time factor.
An options trade is only good for a limited time, and smart options traders know that more often than not an out of the money call will expire before it is sufficiently in the money to be exercised.
This suggests another mistake that many inexperienced options traders make. They approach their trading with an "all-purpose" strategy that doesn’t take differing market conditions into consideration.
Smart options traders will try to learn a range of strategies and experiment with them under a variety of circumstances.
This gives them a much better idea of how the options trading market works, and allows them to quickly become more adept at responding to different market conditions.
Things are much more complicated in the options trading world than they are in regular stock markets. This complexity and diversity allows for greater creativity, and opens up opportunities to profit regardless of which way the market is going.
But it also puts a much greater demand on the trader to know what he or she is doing. Different strategies can be used to give you different results and limit your risks. But the sophisticated nature of some of these strategies can also get you into trouble.
If you don’t know exactly what you are doing you can easily lose much more than you bargained for.
When you are thinking of getting into stock options trading, the best advice is to find an online broker that gives you a combination of low fees and great service.
Look for low fees for stock and options trades, no extra charge for assistance from knowledgeable brokers, in depth advice on trading strategy, and a full range of online tools to help you make intelligent trades.
Join more than 130,000 other satisfied traders by opening an account with TradeKing.com, the online options broker voted by SmartMoney Magazine the #1 discount online broker for stock and options trading 2 years in a row.
Article Source: articlestreet