Big Risks with Popular Options Strategies
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Most option traders have experienced some trading successes along with some unexpected, very often sudden and dramatic, losses. The good news? Well, two small points. One, you're not alone. Two, the problem is in the basic structure of your trades and this you can change. You've probably tried some of the more common trades like a short put where the put is sold, the premium is collected, and the investor hopes that the underlying price will stay somewhere near the initial price or go up slightly. This way the option expires worthlessly, the premium is capped, and the next trade is started. This sounds good and seems to make sense but things don't always go as planned. Everyone knows this but option traders have a particularly keen awareness of this basic fact. When the price goes down, sometimes way down, you can make some defensive adjustments, but if the price continues to drop you're really just locking in your losses. Another trade you can configure to minimize the loss potential is taking that naked put and making it a put spread. The idea behind this is the same. Sell a position, buy a position, collect a premium, and once again hope that the underlying price is going to stay above the credit spread. This new trade, of course, does nothing to stabilize the underlying stock price. If it drops, you can quickly lose the modest premium you already collected and the adjustments you make cannot alter the basic trends. If the price keeps going down you continue to lock in accumulating losses. These types of risks recur frequently in the most common option trades that people do. In order to change the outcome of your trading, you really need to learn a style of trading that matches up better with today's markets.