Money Mistakes: Options Trading

Today’s Money Mistakes is a common one for new investors, especially with the rise of investing apps like Robinhood. We have to be careful we truly understand all the risks that come with any kind of investment.

Tell Us a Little About Yourself

Howdy, I’m Ram from Houston, Texas. I’m originally from a small town in Nepal and moved to the United States in 2013. I’m a full-time professional engineer. My job is to manage large-diameter water line projects both through the design and construction phases. And I’m also a hustler.

Besides my day job, I’m focused on personal finance and financial intelligence. I share my journey and education related to money through my blog DollarforCent

I had been feeling the burnout from 9-5 job for a while, but it wasn’t until the end of telecommuting due to COVID-19, that I started thinking about my way out more seriously. I’m working on my 10-year plan for financial independence. My wife and I have plans to visit our country, travel, and explore other business ventures. 

What Was Your Money Mistake, and When Did You Make It?

For those, who are not familiar with options trading, let’s discuss the following basics of options trading. This will help all to better understand my money mistakes.

My money mistake dates back to when I was just learning to invest in the stock market. I learned a few things about option trading over the internet and I was intrigued. While I was still an amateur in the trading world, buying options was one of my biggest money mistakes. I lost thousands of dollars before I realized I was still a rookie investor.

What Are Options?

Options are contracts tied to the underlying asset that is way cheaper than the stock price. This price is called a strike price. It has an expiry date of either a week, two weeks, or a month. When you execute a contract (by buying or selling an option), you either pay or collect money. This money is called the premium.

When you buy an option contract, you have the right to buy or sell the security on or before the expiry date for the price at the time.  

Different Types of Option Trading

There are two basic types of options – a call option and a put option. You can either buy or sell a call or a put option. These are the four basic trades. The following chart illustrates the four-option trading basics for a beginner.

DiagramDescription automatically generated

A sophisticated investor executes a combination of the basic trades and comes up with a strategy that aligns with his investment goal. If you’d like to learn more about options trading and the trades that result in a higher probability of success, you can read the article on “two best option trading strategies for success” on my blog.

What Led You To Make the Mistake?

I have to admit, trading options is a great investment strategy despite my loss. You must learn how to use them to your advantage. Diving into the pool of options with just the basic information had led to me making this money mistake.

The following are reasons why options trading is a very lucrative investment strategy. As a beginner, I focused more on these reasons than investment risk and risk management.

Low starting cost 

Trading options do not require huge investments to start with. The cost to buy an option is only a fraction of the stock price. For example, one share of an Amazon (AMZN) stock is currently trading at $3,249. You can buy its option for less than $100.

When I first found out about the low-cost benefit of options trading, I was hooked. After all, if you are a beginner, you don’t have thousands of dollars to spare. You’re constantly looking for alternatives to acquire money will a small investment.

Immediate Returns

Unlike stocks, you do not have to go long-term for a profitable return on options. The option expiry date for a stock option is usually the third Friday of the contract month. Therefore, one can exercise options weekly, biweekly, or monthly depending on when s/he chooses to get the contract.

When I was a beginner, I didn’t want to tie my money in the long run. I was looking for a quick profit. Waiting for a maximum of a month resonated with my trading goal at the time.

Profits Regardless of Market Direction

This is probably one of the best advantages of options over individual stocks. You can collect profits when the stock market is going up, down, or sideways. By carefully placing your trades, you can even make money during the market recession.

As a beginner options trader, I mainly focused on these three key option trading benefits.

Stock options are highly risky. It does not take a minute to tank all your winning trades. If you are just a beginner with no advanced knowledge about trading options, it’s very important to get acquainted with different trade strategies, position sizing, and risk management.

How Did You Recover From It?

It was not easy to recover all the money I lost. It took me months to win back the cash I lost in a few days. The process was slow, but I was consistent with my strategy. The following are a series of actions I took to stop loss and recover my investment.

Closed Loosing Positions

This was the first action I took, and believe me when I say, it was the tough one. I was already losing money and was hoping it will pull back up. It was not easy to close the losing positions and lose hope. I realized I had to sell and move on. Had I held on to these positions, I could potentially lose more money.

Closed Winning Positions

I closed out all my winning positions as well. Any options that I sold for a premium, I closed them, once I earned more than 50% of the premium. I didn’t make a lot of money, but I was glad I didn’t lose my investment.

Invested in Index Funds

After I closed out all my options positions, I went old school. I research Index Funds and started investing in good index funds. I started buying index funds and mutual funds with low expense ratios. I purchased the mix of low, mid, and high cap funds for diversification.

Invested in Dividend Stocks

I also started a dividend stock investment. I researched the money and quarterly dividend stocks. These are good investment opportunities for capital gains and dividends.

Used Options Only on the Stock I’d Like To Own

I started selling options only on the stocks I wanted to own. I learned more about options strategies and how to use them to buy stocks at a discounted price. I only traded options with a higher probability of success.

What Would You Have Done Differently?

If I had a choice to do things differently, I would take the following steps before investing in options:

  • I would certainly learn more about options trading before diving right in with the basic information. I would learn about position sizing and risk management.
  • I might consider taking a training where I can learn how to make a trade. I would learn how to adjust my trade when things do not go as planned. Learning when to place the trade and when to exit out of the position are two crucial aspects of option trading
  • Reading books on options trading or stock market investment, in general, will also be one of my to-do list if I could do things differently. There are so many things you can learn from a book. We don’t always have to learn from our mistakes.
  • If possible, I would have avoided trading options completely. Options trading is risky and requires continued attention.

How Can Others Avoid the Same Money Mistake?

Most money mistakes are based on our mindset. We need a mind shift to think creatively.   Based on my experience, you should consider the following to avoid money mistakes.

  1. Do not trade based on limited knowledge. Limited knowledge always clouds your judgment because you do not have all the information. 
  2. Invest money to gain knowledge. Training courses, mentorship, books are great sources of knowledge. You can gain free knowledge if you know where to look for it. You can read my article on hidden benefits of Houston Public Library to find out the wealth of free information.
  3. Start small and learn before making bigger trades. Slow and steady always wins the race. Learn the strategies on the way. 
  4. The stock market is not the only investment vehicle. There are other investment opportunities besides the stock market, which can yield higher returns. As they say – Don’t put all your money in the same basket.
  5. Don’t go after a quick return. This is also for the beginner who wants to make an immediate return on investment. The rapid return scheme is either a scam, or you’d need beginner’s luck.

Most Importantly, What Did You Learn From Your Money Mistake?

The following are some of the lessons I learned about options trading from my money mistake:

  1. Choose highly liquid stock options

Stock’s liquidity is the ability to buy and sell them. Highly liquid stocks are easier to be bought and sold in the market.  You should always choose highly liquid stock options in your options trading portfolio. It will help you get out of a position when you’re ready to close quickly.

  1. Trade on the winning side

I learned to always trade on the winning side. When buying options is also a great strategy, I would always recommend selling options instead of buying them. When you are selling options, time decay will be in your favor. Time decay is the loss of option value over time. 

I would also always select a higher probability of success even though that means less premium. I’d rather take low premium than lose money.

  1. Always place cash-secured trades

Naked calls and puts are risky. I’d always trade cash-secured trades. I would not trade any stock options I don’t want to own. I would never trade options without enough money to buy stocks if it is assigned to me. Buying options using margins is never a good idea.

I would like to quote the famous saying: “Information is potential power.” It will be your power if it is accurate information and you know how to use it. Learn from other experiences, books, and training. If you must learn from your own mistake, start small, so even if you fall, you will not fall hard.