Top 3 reasons for why option traders lose money (2024)

Shubham Agarwal

Options trading has always been an attractive investment opportunity due to its potential for big profits with limited losses for option buyers, as well as the consistency and success rate of option sellers. However, it has been recently discovered that the majority of option traders lose money in the market. In my opinion, this is due to the neglect of some crucial aspects of options trading.

Know Your Enemy in Options Trading becomes very essential. The majority of errors and losses arise out of that. Options are very mathematical when it comes to pricing them. There is still a human element involved, one of the reasons is that.

Many of us tie ourselves to indices like Nifty, Bank Nifty, and Sensex options initially. As soon as we get deeper into the trading game, we start venturing into Stock Options as well.

Reason 1: Different Underlying Different Option Strategy.

The first reason is rather simple to understand. Let's say you have mastered the skill of riding an elephant, and now you want to try riding a cheetah using the same expertise. However, there's a catch. While elephants are slow-moving creatures, cheetahs are fast-moving stocks. Therefore, you cannot expect the same results from both. Even though option sellers find it easy to use index options, they cannot apply the same ease to stock options. A 5% move in an index can halt trading, but it is a normal occurrence in stock options. If, God forbid, there is a double-digit move in a stock and we had sold a call in a rise or sold a put in a fall, we would be out of business.

Solution: Treat Stocks and Indices differently. With stocks the Volatility and Premium both are high, so do not be shy to Buy a Higher Call / Lower Put against a Put or a Call sold. This will avoid any big accidents and limit the losses.

Reason 2: Cheaper is Better Options

Option premiums work on a very scientific methodology. The majority of Options that go up ten or twenty folds are the ones that were a Rupee or so at some point in time. Most of the Option Buyers fancy this extravagant movement. The Potential to make 10X money is real but not frequent.

In search of these, the Traders would often Buy Higher Calls and Lower Strike Puts simply because they are cheap. If the stock does move in a day by a big margin, they would make money as well but if they do not or they do over 10 days, there may not be any money or even a loss.

This reason alone has put away a lot of people out of Options Trading

Solution: Try to Buy Options with not more than 2-3 strikes away from the strike closest to the current market price.

Reason 3: Buying into Illiquidity

Many Options or entirely stocks do not have liquidity. This not only makes the entry difficult due to the difficulty of getting a good bargain but also makes an exit difficult. At times in many stock options, there are no quotes after a big move. This makes it impossible to book profits.

Solution: Trade Options where both Volume and Open Interest is more than 50 Lots.

Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

Shubham Agarwal is a CEO & Head of Research at Quantsapp Pvt. Ltd.He has been into many major kinds of market research and has been a programmer himself in Tens of programming languages.Earlier to the current position, Shubham has served for Motilal Oswal as Head of Quantitative, Technical & Derivatives Research and as a Technical Analyst at JM Financial.

first published: Mar 30, 2024 07:05 am

Discover the latest business news, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!