About once a year in MTM’s Group Coaching class I go over common option trading mistakes and things to think about as an option trader. It’s a series of several presentations, and each contains five tidbits. There were two recently that inspired me to write this blog: having too many low risk/high reward trades and, just the opposite, having too many low reward/high risk trades.
Don’t Overdo It
With many things in life, too much of a good thing isn’t good at all. The same can be said about option strategies. Taking exclusively low risk/high reward trades is usually not good. An example would be buying cheap options that have a high potential reward. It can work sometimes. For example, when the pandemic started several years ago and buying long calls like on GameStop made a lot of money for many people. But generally, buying cheap out-of-the-money (OTM) options is a losing endeavor.
The Flip Side
On the flip side, taking too many low reward/high risk trades also isn’t a good thing. A great example is when an option trader does mostly OTM vertical credit spreads. These are high probability trades on paper because they essentially have 3 out of 4 ways to make money. An example would be selling a bear call spread above where the underlying is trading. The underlying can move lower, trade sideways or even move a certain amount higher and still profit. Well, guess what? Those trades risk a lot more than the profit potential. So even though the probability is very high, when one of these trades goes against you, it can result in a big loss that can clear out a lot of previous profits.
Mix It Up
No one is saying you should be totally spread across the board and have a perfect mix of option trades at any given time. Just be careful if you are top heavy with one or two in particular. Take a look at your portfolio of option trades from time to time. If you don’t, it can really be detrimental to your trading.
Senior Options Instructor