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Tuesday, December 05, 2006

The 7 Deadly Sins Of Options Trading

From the Options University

#1 Not fully understanding the independent effects of time and volatility on your option

#2 Forcing a pre-selected strategy on every opportunity

#3 Not fully understanding the proper meaning of leverage as applied to trading

#4 Not fully understanding the foundations or building blocks of option theory

#5 Thinking that cheapness or expensiveness of options is determined by dollar cost

#6 Overcomplicating otherwise simple strategies

#7 Not knowing how to pick the correct option for the selected strategy

Personally, I've committed #1, #5, #7 sin most often when I first started trading options. In fact, the biggest joke of all is that I didn't even take note of IV when I first started. And it certainly took me quite awhile to figure out #7. But I have no problem at all with #6. I always like to KISS (keep it simple & stupid!)


6 Comments:

Blogger adam said...

#6 is my biggest flaw, i can handle the others, lol.

1:10 AM  
Blogger Simply Options Trader said...

lol, you are the exact opposite of me. I wonder if it has got to do with the fact that you used to trade on the floor?

9:22 AM  
Blogger AJ said...

How do you make use of IV while trading options? And, how do you keep it simple ? , so you just buy calls / puts?
Thanks for the wonderful site.
AJ.

10:13 AM  
Blogger Simply Options Trader said...

hi AJ,
Yes, I mostly just buy calls/puts. Occasionally I have straddle and strangle trades, but they are mainly for participating in earnings. I don't do combination spreads or synthetic positioning. I'm not saying they are no good, just not suited for me right now.

IV helps to determine whether the option is overpriced or underpriced. I compare the IV with the HV, and this is exceptionally useful when it comes to earnings play.

11:19 AM  
Blogger AJ said...

Hi, could you elaborate a little further on how you make use of IV and HV please? Also, do you use some software that determines the fair price of an option using IV?
Thanks,
AJ.

12:02 PM  
Blogger Simply Options Trader said...

You can go to ivolatility.com to see both the IV & HV for any stock. If IV is higher than HV, it is deemed over-priced. I would say that if there is earnings report coming up or some legal settlement or any other catalysts upcoming, IV tends to rise as volatility is expected in this stock. There is very likely to have volatility sell-off after such events, so be careful here.

I don't use any software to determine "fair value". The most I use is the option pricer in OX or options calculator which can be downloaded from CBOE.

I would also recommend Adam's blog if you are interested to know more about volatility. He has some very good posts on this topic

2:45 PM  

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