New option traders often fall into traps that are actually not too difficult to avoid – if you know about them! Some of the most common mistakes are made as the new option trader learns about how options behave as compared to the stocks that they might be more familiar with. We’ve captured a short survey of some of the more common mistakes made by new option traders to help you steer clear.
1. Buying too little time
Since time can be a significant component of how an option is priced; it’s important to understand how time progression affects option valuation. Option traders make the mistake of buying too little time. Since time only goes one way, the time component of an option’s value will decline as expiration approaches.
2. Unrealistic expectations
Traders tend to have unrealistic expectation of the stocks they analyze and purchase options that have low probabilities of being profitable.
3. Buying options on highly volatile stocks
The third mistake involves buying options on highly volatile stocks. Option traders tend to focus on stocks with high volatility assuming the increased volatility will offset the effects of time decay. It actually does the opposite. The higher the stock’s volatility, the more expensive the calls and puts will be.