Ever wondered why some traders make consistent profits in Options Trading while others struggle in the red? Learn the hard truths about buying call options and how you can avoid deadly mistakes that burn up your capital! Read on to discover the five costly pitfalls most beginner options traders make – and how to counter them!
Mistake 1: Buying a Call Option Like It’s Your Lottery Ticket to Riches
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The first mistake many options traders make is treating buying a call option like a lottery ticket. The plan sounds easy enough — the stock price moves quickly in your desired direction, you make money.
But for this approach to be profitable, not only do you have to get the direction right, it has to move significantly enough from your strike price, and it has to be done within a specific time period. If any of these three criteria are not met, you might sit on a losing trade.
So this method can be expensive compared to other options strategies and carries a low win rate, akin to gambling on chance.
To give you an example, let’s assume that you bought the following call option on Tesla stock:
TSLA Jul 26 200 Call at $10
Assume that Tesla was trading at $190 on 26 June, and you bought a 1-month out call option.
With this option, your breakeven point is $200 + $10 (premium paid upfront) = $210. At expiration you’ll profit anything above the $210. On the flipside, if Tesla is below $210, you’ll lose anywhere between $0 to $10 (maximum loss) from the premiums paid. Each contract is equal to 100 shares, so the figures above will be multiplied by 100.
Here’s the thing, Tesla may very well swing to the upside, way above $210 – but maybe not within this month. If it does so in the month of November instead, and you’re just one month early, you will not be able to enjoy any upside (even though you got the direction right).
Now, let’s assume Tesla does see some recovery in the month. At the tail-end of the contract, Tesla rallied from $190 to $205. But because the breakeven point is $210, you still lost money because the stock didn’t rally enough from your chosen strike price.
See, beginner traders tend to forget one deadly element that works against the buyer — time decay. The value of the option erodes over time, which diminishes profits or even incurs losses if the stock price doesn't move in the trader’s favor fast enough.
💡PRO TIP:
Make sure to practice risk management instead of relying solely on speculative trades. Educate yourself on the different options trading strategies available and apply the right ones in different scenarios to lift your win rate.
Mistake 2: Buying a Call Option without Applying Technical Analysis
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The next deadly error is purchasing a call option without conducting proper technical analysis on the stock’s chart. Many amateur traders succumb to FOMO (fear of missing out) and trade blindly based on news, friends’ advice or gut feel. Remember, even if a stock is touted as promising, it could be in a temporary downtrend, meaning its price may not go up immediately.
Take for example this chart which depicts the price action of the Chinese EV manufacturer NIO. They’ve been locked in this downward trend since February 2021. Traders trying to time the rebound may buy call options in a specific time period. But with NIO making lower highs and lower lows, their chance of profit is slim.
While purchasing long-dated options (such as call leap options) with expiration dates two years out may seem like a solution, the premium attached to these options is often expensive.
If the stock gets locked in a downtrend for an extended period of time, even a long-dated option cannot make you profitable. Remember that when you buy a call option, time works against you and the option loses value with each passing day.
💡PRO TIP:
Make sure to master the basics of technical analysis, using different indicators (the more confluences, the better) to increase the probability of making your options entry at the right time.
Mistake 3: Buying a Call Option with Short Expiration Dates
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Buying call options with short expiration dates requires precise timing and market forecasting, so it leaves us very little margin for error. Limited time + limited flexibility = a recipe for disaster.
Options with short expiration dates have less time for the underlying stock to move in the desired direction. If the stock price doesn’t move quickly or sufficiently within the limited timeframe, the options may expire worthless. The time decay speeds up as the option is nearing expiration, so you’re actually losing more and more money.
💡PRO TIP:
Consider purchasing options with expiration dates further out, so that you have more time and flexibility to roll and repair your position even if the trade goes south.
Mistake 4: Buying a Call Option on Stocks with Low Liquidity
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The fourth mistake involves purchasing a call option on illiquid stocks. Not all stocks have options available for trading, and even among those that do, not all stocks are suitable for trading.
Stocks with low liquidity often have wider bid-ask spreads and lower trading volume in the options market. This can make it difficult to close the position at a favorable price, and traders may be forced to hold on to the contract until it expires.
Also, low liquidity may indicate lack of interest or activity in the underlying stock, increasing the risk of unfavorable price movements.
💡PRO TIP:
Focus on trading options on stocks that have a weekly option chain - which means that there is sufficient liquidity / interest around the option.
Mistake 5: Buying a Call Option When the Stock Is Crashing
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This is the WORST mistake of them all. Buying a call option right when the stock crashes might sound like a very lucrative idea — you’re basically betting for an immediate rebound. However, this might actually do you more harm than good.
Firstly, during a stock price crash, volatility tends to surge, causing option premiums to skyrocket. As a result, traders end up paying inflated prices for options due to the heightened volatility. However, once the stock stabilizes and begins to recover, volatility tends to decrease, leading to a decline in the option’s value.
This means that you lose the volatility premium you initially paid for, resulting in reduced profits even if the stock price rebounds. And let’s not forget that it is incredibly difficult to accurately time the market bottom, leading to further losses if the downtrend continues. This misconception has cost many beginner options traders a ton of money.
💡PRO TIP:
Don’t let your emotions rule your trades, because it might lead to impulsive decisions. Look for indications that the stock price has found support, even showing signs of potential recovery. Use different options strategies that take advantage of heightened volatility, while managing risk. Patience, careful analysis, and prudent risk management will make you a much more successful and profitable trader.
A Better Way to Trade Options: Buying and Selling a Call Option at the Same Time
When you purchase a single option (one leg), you expose your trade to the unnecessary downside of expensive premiums, time decay and falling volatility. To counter these risks, you can use the BCS options strategy that deploys two option legs.
With this strategy, you’re able to reap the profit potential of purchasing a call, while at the same time mitigate the time decay element. Furthermore, this strategy ensures a much lower breakeven point compared to buying a call option outright, making the trade more cost-effective.
Resources for Further Learning
You're in luck! The BCS options strategy is one of the core strategies we cover in our Options Waverider™ Membership.
The first step is believing you can fully commit to trading firmly. And the next step will be to get a solid foundation of your knowledge.
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