Did you know that fear has nothing to do with logical or cognitive reasoning? It's actually a completely physical response that originates in our body. We fear being wrong because that might mean we will be alone and people will leave us, which means that we won't be part of a tribe or community, which means it'll be dangerous and we might die. Okay, that's extreme. But, taken to its logical conclusion, we fear because of conditioning we've had as humans for thousands of years to survive on a physical level. As options traders, we have fears about trading that manifest in dozens and dozens of ways. Today, as we circle the Halloween season, I wanted to tackle the 27 biggest options trading fears that we hear in our community. And, more importantly, how to overcome and conquer these fears. Just saying them out loud and talking through them together might be just what you need to set yourself free and on the right path as a trader.
1. Using the Right Strategy
- There are lots of strategies out there. The right strategy for you is the one that is most appropriate for your risk profile and for the market situation.
- Different strategies may work well in the same market environment--it’s just the risk profile that differs.
- Ultimately, we believe the right strategy starts with the core idea of being an options seller and figuring out what works best for your account.
- There is no unicorn strategy or one strategy that works in all situations and all environments.
2. The Risk-Reward Ratio
- I have had it drilled into me that the risk to reward has to be at least 2:1. How do I know this is a good trade because it seems like that balance is out of line?
- The risk to reward is only one component of the calculation.
- If you have a positive expected outcome, you shouldn't worry about how much money you should or could lose versus how much you could or should make.
- What matters is the expected outcome and the probability of making the small premium versus the probability of losing a larger amount.
3. Fear of Commissions and Scams
- Is my account dying a death by a thousand commissions?
- As more and more brokers go to zero, that helps reduce commission fears.
- Many brokers don't actually make a lot of money based on commissions.
- In many cases, commissions are a very small percentage of what a broker generates.
- Most broker profits come from fees, management fees, custodial fees, margins, borrowing, and lending.
- Assignment and exercising is simply part of the process of being an options trader.
- It does not always result in a losing trade as evidenced by the case studies we have shared. (Check out OAP 142: EWZ Short Put Option Assignment Case Study.)
- Assignment does not mean the death of a position.
- You can and should manage positions around assignment -- it's part of the business and you should learn how it works.
- You should expect that it will happen and know that you can manage it.
5. Diminishing Profit During Price Discovery
- This is usually a byproduct of an illiquid market.
- You need high liquidity in order to have the price discovery happen quickly in the market after an event and get out of the trade.
- The problem with getting trades filled is not necessarily the price - it's finding the alternate party to do it.
- When there is no alternative party, you have to reduce or increase your price to entice them.
- Therefore, you should focus on highly liquid underlyings.
6. Opening Order Blunders
- The key is to learn to manage a small account so that initial mistakes don't have such a great impact.
- When you do make a mistake, quickly reverse the trade.
- To prevent from making these order blunders, read the order out loud and don't rush the order entry process.
- There will always be another trade and another opportunity, so don't rush the process.
7. The Unknown (Black Swan Events)
- The fear of the unknown is human nature.
- If you have the right management protocols in place (small position sizes, ample cash, neutral portfolio) it is going to sting if you go through a big market event, but it's not going to kill your account.
- If you have enough capital available to keep trading, you will be okay in the end.
8. Missing an Opportunity to Adjust
- Hindsight is always 20/20.
- Adjusting is better in the last couple of weeks of expiration.
- Remember, it has to be the right move for that opportunity based on expected outcomes.
- More often than not, you have to be very patient with your adjustments.
9. Picking Good Stocks
- A "good stock" is just whatever you deem a good stock to be.
- The “right stock” depends on what type of trader you are and what stock fits best with your strategy.
- Diversify your tickers with uncorrelated pairs.
10. Holding on to a Losing Position too Long.
- Traders often have rules for handling winners, but there are not as many rules and processes for exiting losing trades.
- Holding on to losing positions for too long is something you only realize in hindsight.
- You might have passed up an opportunity to close a winning trade and it subsequently turns into a losing trade.
- This is when you should get back to your expected outcome: what is the best thing for you to do in this scenario?
- When it comes to losing trades, the strategy is to hold on to it for as long as possible to give the market a chance to bounce back, for the probabilities to work, and for the expected outcomes to come to pass.
- Remember: probabilities in options trading are probabilities based on the expiration date.
- You have to let the trade work itself out over time and adjust along the way.
11. Fluctuation of Options Prices
- Option pricing is multi-dimensional--especially compared to stock pricing--with a lot of varying factors.
- However, with an understanding of how each factor impacts the pricing and watching how the markets progress, you will get the feel for how pricing evolves.
- The key is to work within the boundaries of each factor - time decay, implied volatility, etc. - because these remain constant.
12. Being Exercised
- Again, being exercised is part of the business as an options trader.
- You should learn how to deal with assignment instead of fearing it.
- Don't lose track of your P&L's and the premium that you've collected.
- The key is to slow down and really understand your position.
- Adjusting positions should be a marginal improvement on your core strategy.
- The baseline scenario is to let trades go to expiration.
- If you are using a strategy that takes advantage of IV, you have profit-taking orders and if they don't work out you just let the trade go to expiration, which should generate a positive expected outcome.
- Adjusting is not about turning everything around: it's about taking a trade that will lose $500 and cutting that down to a loss of $100.
14. Never Achieving Success (90% Failure)
- Oftentimes it's not failure, it's the fact that traders have simply quit.
- If you quit in this process, then, of course, you will never be successful.
- Success may not happen in the first month, you have to be persistent to see it pay off in the long run.
- If you are willing to quit, then you will be part of the 90% failure crowd.
15. Being Wrong on Your Expectations
- This fear is linked to a personal need to be "right.” The obsessive need to be right is pervasive.
- No one knows where the stock is going to go - there is no certainty in the market.
- However, you don't have to know what the market is going to do in order to be successful in this business.
- The key is to take advantage of the overstatement of implied volatility.
16. Trading Neutral on a Runaway Bear or Bull Market
- Runaway markets are tough because you feel like you've missed an opportunity.
- Options trading is short duration, giving you time to readjust to the new market price.
- Although you might miss the initial large runs, you will capture the big range over time.
- Continuously adjust your positions and your portfolio to accommodate wherever the market is going.
17. Having 10 Winners in a Row and Losing all of it in One Losing Trade
- This is something that is inevitable in the options trading business.
- Again, if you are playing a positive expected outcome game it's just a matter of getting a higher trade count in your portfolio and surviving those tough environments to keep going.
18. Being Discouraged by Your Own Mistakes
- Mistakes are bound to happen while trading.
- Learn from your mistakes, pick yourself up, and keep going.
- If you want to be successful, you just have to survive and keep going.
- Outlast everyone else.
19. Taking Profits off too Early
- The idea of “not taking profits early enough” is a scarcity mindset.
- You have to be patient and diligent enough to let profits come in.
- Let the profits on a position come to you and take them off at an appropriate time.
- Don't act too quickly for fear that you will miss out in the future.
20. Losing More Money
- Having losing trades/months is just part of the business.
- One way or another, you will lose your money to something at some point.
- All investments have risks!
- Even money in a safe, secure savings account is losing purchasing power due to inflation.
- Trading and investing require managing risk appropriately.
21. It's Never Going to Fully Click
- There will always be more for you to learn as a trader.
- You have to have the growth mindset that nothing is going to ever fully click because markets are evolving.
- You should be excited and passionate about learning how the changes in technology and the market are going to impact you.
- There is no single definitive point in the future where you will know everything that you'll need to know.
22. The Trade Goes Deep in the Money Against You
- Position size and portfolio balance matter more than a single position that goes against you.
- A single position going against you should never impact your entire portfolio.
- If your position size is correct (small enough), then a position that goes against you will hurt, but it will never kill you.
23. Massive Fear of Losing Money on a Small Account
- The first step is to save more money in order to grow your account.
- Start with high probability, low-risk trades - dollar wide spreads are a good risk-defined place to start.
24. Fear of Not Knowing What You are Doing
- When you get started, there will definitely be a lot of things that you don't know.
- This is where paper trading on a platform can be very helpful and beneficial to start.
- Paper trading will get you familiar with the order flow and how markets move without experiencing actual losses.
- There is a learning curve when you first get started.
- Give yourself enough wiggle room to learn as you go.
25. Fear of Not Following the Rules
- It is human nature to break rules--all the time.
- The key is to have a few cardinal rules that are simply unbreakable.
- Implement guidelines--instead of rules--to use in your process.
- Rules like no more than 5% position size or no more than 50% of capital allocated to options are meant to not be broken; they keep you safe.
- Assign someone to double-check your decisions/trades and keep you accountable.
26. Being on the Wrong Side of a Trade
- It is inevitable that you end up on the wrong side of a trade.
- In many cases, you might be on the wrong side of a trade 30-50% of the time.
- There is no unicorn strategy or 100% probability of success trades.
- You will have losing trades, and that is okay.
27. The Daily Instability of the World Caused by Trump
- We will always have some unknown trigger that will cause us to fear instability or market events.
- This is a wonderful thing because this is why people buy options.
- There will always be a catalyst for why people fear something in the world.
- Build a portfolio that protects you in case those black swan events come true.
- Focus on what you can control: position sizing, balancing your portfolio, trading diversified tickers, having a high trade count, and adjusting positions that need adjusting.
Option Trader Q&A w/ Jason
Trader Q&A is our favorite segment of the show because we get to hear from one of our community members and help answer their questions live on the air. Today's question comes from Jason:
In “perfect pricing” for options strategies, the credit that you receive should be greater than or equal to the width of the strikes times the probability of being in the money. Can you expand on this?
Remember, if you’d like to get your question answered here on the podcast or LIVE on Facebook & Periscope, head over to OptionAlpha.com/ASK and click the big red record button in the middle of the screen and leave me a private voicemail. There’s no software to download or install and it’s incredibly easy.