3 Mistakes To Avoid When Trading Options
As Charles Schwab (SCHW) led the charge into zero commission trading — which was quickly followed by everyone from other discount brokers such as E*Trade (ETFC) to full-service funds such as Fidelity – was rightly viewed as a boon for most traders.
But one of the unintended consequences might have been that ‘no transactions fees’ might come at a cost, especially to the retail stores or individuals it was meant to benefit, as it exacerbates some common errors.
Here are three mistakes that free trading has exacerbated and how to avoid them.
1. Overtrading
The ease and quickness with which electronic platforms combined with no fees have made trading a point-and-click process has hastened the spray-and-pray approach to trading.
No commissions allows active traders to place orders first and then think about the consequences later. The attitude seems to be, “Let me establish the position and if it doesn’t go my way and I’ll just close it, no harm is done.”
The problem with this, especially with options, which still carry a typical $0.65 per contract fee, is that price slippage, which can cause losses to rack up even when nothing has happened.
Worse, is the tendency for people to get married a position and try to trade out of it, because after it all, trading is free.
2. Placing Market Orders
When trading options, I’m adamant about using limit orders, or those with a specified execution price. The bid/ask spread in options markets, especially in the open minutes or with fast-moving stocks can be brutally wide.
For example, last week when “Beyond Meat (BYND)” shares were halted after being up 15% the bid the 140 call was $4 and the ask is $6, a whopping 40%. If one is to enter and exit a trade using market orders, you’d give away 80% of fair value or what most likely would be any potential profit.
Don’t let low/free commissions lead into thinking you can afford to give away the edge on order execution. Stick with price limits.
3. Too Many Orders
The flip side of the above is entering too many limit orders on the notion “I’ll get filled on a few” and go from there.
Again, the ease in terms of both mechanics and cost doesn’t translate into taking a more the merrier approach to trading. Leaving a scattershot of open orders can only lead to trouble.
When commissions were $10-$20 per trade, it created an entry fee and forced a more considered approach. One tended to only pursue their best ideas and tried to execute the trades at optimal prices.
Remember, there are no bad trades, only bad prices. Don’t let those ‘free’ transaction fees lead you into taking bad prices which turn into very real losses.
Note: This article originally appeared at Option Sensei.
Category: Options Trading
