Popular Options Strategies Yield Common Problems – Part 1

Here’s an overview of a couple of the most popular option trading strategies. The risks involved with these strategies are pointed out and why they so often fail in volatile markets is also explained. Naked Puts and Credit Spreads are up first.

Most option traders have some early successes and that’s what keeps them trading. Most option traders also experience some very significant failures that make them question their approach and their understanding of options trading.

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.

As a variation on this theme, you can trade a put spread, in an effort to minimize your potential for loss. But a deep look reveals the same basic structural limitations. Once you again you’re selling a position, buying a position, collecting a premium and hoping the price stays above your credit spread.

The problem remains that the underlying price doesn’t always do what you want it to do. As the price drops, you can make some adjustments but you’re already eroding the small premium you collected. You also maintain a significant risk so that if the underlying price continues to drop you’re just going to lock in more and more losses.

Losses just like this are terribly common with these kinds of trading tactics.

Learn how to Trade Options with lower risk at San Jose Options! Take an Options Course that can change your life!