Tuesday, January 07, 2014

The Biggest Problem on Being a Profitable Options Trader

The Biggest Enemy of Newbie Options Traders by Market Authority

Many inexperienced options traders believe that if they buy an option with a later expiration date, they can afford to sit and wait for the position to move in their favor.

The reality of holding longer-dated options is this - Time is not your friend. If you believe that buying options 3 months, 6 months, or 1 year until expiration is a viable strategy- you need to, in the immortal words of rapper Ice Cube, “check yo self before you wreck yo self…”

Ice Cube says, “Don’t buy longer-dated unhedged options, go for the drive-by!”

A better strategy is to trade for the “drive-by”, quick hit trade. Don’t sit on naked (unhedged) puts or calls. Buying naked puts or calls is merely adding leverage to your portfolio, and there are many factors working against you while you’re holding them. The opportunity to add leverage to your portfolio is costly, and you’re losing $ every day you hold them.

This is a chart of how your options lose value on a daily basis…

You can see how you lose $ everyday and you lose the most amount closer to expiration. Even options 3 months out shows rapid decay.

Remember this when you purchase an option – someone on the other side is selling that contract to you. And this someone is typically a market maker that can not only calculate 3rd derivatives in his head, but also has hand-held software that can give Gary Kasparov a run for his money in chess. You may win here or there, but in the long run, you will lose all your money. That’s a fact, jack.

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