Biggest mistakes of an Option buyer

Change in regulations is brining in a need to create more directional strategies. This requires us to be a Buyer of the option or a net Buyer of the option in most cases. Net buyer means we end up paying premium when we create the strategy.

If it is directional trading we will have to thing beyond indices like Nifty, Bank Nifty, Sensex option. As soon as we get deeper into the directional trading, we start venturing into Stock Options as well.

Most of us option traders have a decent grip of option writing. We all know that when it comes to buying options, we need to deal with many other difficulties. In order to avoid many of them we end up making mistakes.

Let us look at what those mistakes could be and find a solution for the same.

Mistake1: One size fit all Strategy

Imagine you master riding an elephant and would like to try using the same expertise and ride a cheetah.

Elephant being slow moving indices and cheetah being the stocks will never give us the same output. Especially the ease with which Option Sellers use Index Options, the same ease can not be applied in stock options. 5% move in an index in a day may halt the trading but 5% move in a stock is very normal.

We need a solid strategy especially when writing options on stocks for directional trading.

Solution: Treat Stocks and Indices differently. With stocks the Volatility and Premium both are high, so do not be shy to Buy a Higher Call / Lower Put against a Put or a Call sold. This will avoid any big accidents and limit the losses.

Mistake 2: Lower Premium Does not make it Better Options

Option premiums work very scientifically. Majority of Options that go up ten or twenty folds are the ones that were a Rupee or so at some point in time. Most of the Option Buyers fancy this extravagant movement. The Potential to make 10X money is real but not frequent.

In search of these the Traders would often Buy Higher Calls and Lower Strike Puts simply because they are inexpensive. If the stock does move in a day by a big margin, they would make money as well but if they do not or they do over a period of 10 days, there may not be any money or even a loss.

This mistake alone has put away a lot of people out of Options Trading.

Solution: Try to Buy Options with not more than 2-3 strike away from the strike closest to the current market price.

Mistake 3: Buying into Illiquidity

Many Options stocks do not have enough liquidity. This not only make the entry difficult due to difficult to get a good bargain but also make an exit difficult. At times in many stock options there are no quotes after a big move. This makes it impossible to book profits.

Solution: Trade Options where both Volume and Open Interest is more than 50 Lots.