If you trade options and are struggling to find consistency or profitability, it's likely a result of breaking, knowingly or unknowingly, some important rules. Rules that are designed to keep you safe, protect your portfolio, and cater to the math and probabilities that drive any options selling system. In this episode, I'll walk through the 11 common options strategy mistakes you might be making right now. Plus, we'll talk about the core principle or rule associated with each of the mistakes, which will help you quickly correct your trading system and ultimately find success sooner.
1. Position Size
- Position size is absolutely the biggest mistake traders make, where traders enter into positions that are too large.
- The only thing that really kills your account long-term is sequencing risk (see OAP 139: The 4 “Not-So-Obvious” Ways To Avoid Blowing Up Your Trading Account).
- Correct position sizing counteracts sequencing risk long-term.
- Position size in any individual ticker should not exceed 5% of your overall trading account.
2. Low Trade Count
- Traders make the assumption that the win percentage is always true for every trade.
- However, trading is a probability game.
- You need to trade long-term so that your trade count more accurately reflects the expected outcome.
- Win rates really only start to solidify over the long-term after making hundreds of trades.
3. Diversity of Tickers
- Having a diversity of tickers that you are trading is key.
- The risk in trading one ticker is that you have a ton of risk if that one ticker becomes unstable and volatile.
- You should have at least 10 to 15 tickers that you trade every single month (see OAP 143: What’s The Rationale Behind Entering New Option Trades?).
- Diversity in tickers gives you the flexibility to have a losing trade without blowing up your whole portfolio.
4. Portfolio Balance
- You cannot be a one-sided trader; it's just too risky.
- If you are going to be trading options, you need to do so on a portfolio-neutral basis.
- Having a neutral portfolio is what the largest institutions do on an on-going basis.
- You should be overall neutral to a lot of the market movements so that a massive move in one direction or another does not hurt you.
5. Option Buying Versus Selling
- Option buying just does not work as a long-term income strategy.
- As option buyers, you end up paying the implied volatility premium.
- You have to be more of an option seller than an option buyer.
6. Using the Stop-Loss Order.
- Stop-loss orders create more losing trades (see OAP 067: The Stop Loss Myth – 10 Backtested Option Strategies Prove They Create More Losing Trades).
- Backtested strategies prove that using stop-losses create more losing trades in multiple environments and multiple situations.
- Using stop-losses as a core strategy is not good for your portfolio.
- The better alternative is managing risk through position-sizing.
7. Not Exiting Positions Early
- In many respects, exiting early ends up increasing our win rates and reducing the time that we're in the trade.
- Exiting early reduces drawdowns and allows us to recycle capital more quickly in our account.
- Using exit targets is a very viable strategy across the board for increasing returns.
8. Total Account Allocation is Too High
- No one ticker symbol should represent more than 5% of your total account.
- Allocating around 30% of your account tends to be one of the more optimal allocation zones.
- This means that on an on-going basis, 70% of your account should sit in cash as a cushion.
- Options trading is highly leveraged. So when you win, you win massive returns from an options strategy on a small portion of your account, which more than makes up for the amount of cash that you have sitting in your account.
- However, if you over-allocate and have a bad string of trades, you can get wiped out immediately.
9. Reducing Commissions
- Negotiate with your broker and move to a platform that has lower commissions.
- Most brokers are moving towards a commission-free platform.
- Use these platforms to your advantage to negotiate better commissions or reduce the commissions you are already paying.
- Reduce the fees associated with generating your return.
10. Adjusting to Reduced Risk
- The mistake that traders are making is that they are adjusting to increase profit potential, which is not what you should be doing.
- You should be trying to curb the loss that you have in the position.
- A lot of traders give up at expiration, which is probably the worst thing you could do.
- If you could take a trade that should lose $700 and cut the risk down to $300, so you can lose less, this creates a winning trading strategy.
- Take the losing trades and adjust them down in risk by rolling, adjusting, moving sides closer, adding positions, etc.
- This creates a winning strategy because you can cut the risk.
11. Fighting Back
- Fighting back against the market is just an emotional thing that people do.
- The sooner you realize that you have no control over the market and anything can happen at any time, the better off you're going to be.
- So stop pushing back against the market and welcome the volatility and unexpectedness as your friend.
- Most trading follows the 80/20 rule; 80% of what you do is just psychological and getting through the mental barriers that you have put up in your mind. The remaining 20% of trading is the mechanics of strategy, trade entry, etc.
