SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Trader’s Mindset: Oblivious to Risks


Here’s one of the most perplexing risk evaluations I ever heard (read) from a seller of naked options: "I was never in any danger. The stock was always higher than the strike price of the puts I am short." This person was convinced that the only time risk must be considered occurs when short options move into the money.

If the options were out of the money, and remained OTM, then the options would expire worthless and the seller would have a tidy profit.

 

I can’t argue with the 2nd sentence. Options that are OTM once expiration day has come and gone are worthless.

 

However, that mind-boggling first sentence is believed by more people than common senses would suggest.

 

Once of the basic truths about investing (even when it would be more truthful to refer to it as gambling) is that some people with little experience believe that it’s easy to make lots of money in a hurry. I don’t know why that’s true, but the fact that skills must be developed over time is a foreign concept to such believers.

 

Confidence that a current investment will eventually work out is common. Stocks decline and many investors like to add to their positions, increasing their risk in a losing trade. The mindset is that the stock only has to rally so far to reach the break-even point. For example, buy 1,000 shares at $50, then buy 1,000 shares at $40 and the beak-even is ‘only’ 45. Add another 1,000 shares at $30 and the trader’s mindset is that this stock will easily get back to $40, the new break-even price.

 

There is no consideration for the possibility that this company will soon be out of business. This investing newcomer just knows that his original analysis must be correct. This is the mindset of overconfidence. In a situation such as this, it’s also being oblivious to the real world.

 

The naked put seller

 

The put seller described above believes that being short an out of the money option is of no concern, as long as it remains OTM. He just doesn’t get it. The possibility of losing a significant sum is staring him in the face and he truly doesn’t recognize the danger.

 

I’m not suggesting that this oblivious mindset is common. However, as option traders we must be careful to avoid that mindset. I’m sure that every reader here understands the risk of being short naked options. However, being oblivious to other risks can result in a disaster. How large of a disaster? That depends on just how blind the trader is to the true risk of a position.

 

risk-vs-reward-in-trading.jpg

If you are not a member yet, you can join our forum discussions for answers to all your options questions.

 

The spread seller

 

As an example, let’s look at a trader’s whose preferred strategy is to sell OTM put spreads, rather than selling naked puts. This is a common strategy for bullish investors.

 

Let’s assume that one trader correctly decides that selling 10 puts with a strike price of $50 is the proper size for his/her account. Even oblivious traders understand that the maximum loss is $50,000. They also recognize that the chance of losing that amount is almost zero, and that it is difficult to know just how large the maximum loss is. Sure, a stop loss order can establish that limit, but stocks have been known to gap through a stop loss, leaving the trader with a much larger loss than anticipated. The ‘flash crash’ was an extreme example of how bad things can get.

 

What happens when this trader decides that selling naked puts is no longer the best idea and opts to sell 5-point put spreads. Each spread can lose no more than $500 (less the premium collected). The problem arises if the trader, not understanding risk, decides that selling 100 of these spreads – with a maximum loss of (less than) the same $50,000 – is a trade with essentially the same risk.

 

When a trader is not paying attention, he/she can become blind when the total money at risk is similar for two different trades. It’s easy to incorrectly believe that risk must be similar. In this example, two positions have vastly different risk.

 

Position size and probability

 

The trader whose mindset includes being oblivious to reality, is either unaware of statistics or ignores them. The big factor here is probability. There is a reasonable probability of incurring the maximum possible loss when selling 100 (or any other number) of 5-point credit spreads. Depending on the strike prices and the volatility of the underlying, the chances of losing it all can be near near zero to almost 50%, depending on the strikes chosen. Let’s ignore the ‘near zero’ examples because the premium available when selling such spreads is tiny and no one should be trading those on a regular basis.

 

However, when the chances are one in five, or even one in 10, you know that such results are going to occur (on average) every five or ten months. It takes some good sized wins to be able to withstand those losses. But the truth is that the trader who is not aware of the difference between the chance of losing $50,000 no more than once in a lifetime vs. losing that amount at least once every year has no chance to find success.

 

One important aspect of risk management is understanding how likely it is to collect he profit or incur the loss. The size of that profit or loss is not enough to tell the whole story.

 

Please do not be an oblivious investor. Please understand risk and reward for every trade, as well as for your entire portfolio.

 

Related Articles

 

Want to follow us and see how we trade options while reducing the risk?

 

Start Your Free Trial

    What Is SteadyOptions?

    Full Trading Plan

    Complete Portfolio Approach

    Diversified Options Strategies

    Exclusive Community Forum

    Steady And Consistent Gains

    High Quality Education

    Risk Management, Portfolio Size

    Performance based on real fills

    Try It Free

    Non-directional Options Strategies

    10-15 trade Ideas Per Month

    Targets 5-7% Monthly Net Return

    Visit our Education Center

    Recent Articles

    Articles

    • 8 Strategies For High Volatility Markets

      Trading in high-vol environments requires a different approach from low-vol markets. Here are 8 strategies to improve your trading and help you to survive in high volatility markets. They are very different from strategies in low volatility environment.

      By TFCAB,

      • 0 comments
      • 12 views
    • Selling Options Premium: Myths Vs. Reality

      Selling Options Premium refers to certain set of strategies that involve net selling of options, as opposed to buying premium where you are net buyer of options. There are a lot of myths and misconceptions about Selling Options Premium. This article will explain the basic concepts and debunk some of the myths.

      By Kim,

      • 0 comments
      • 359 views
    • Combining Momentum and Put Selling (Updated)

      In February of 2017, I wrote an article about combining together the concepts of momentum and put selling. You can find that article here as prerequisite reading. With this post, we'll look at how the strategy presented has done since then, along with some additional implementation ideas.

      By Jesse,

      • 2 comments
      • 307 views
    • Options and Invisible Risks

      Entry and exit timing is crucial to successful options trading, without doubt. However, one form of risk not often acknowledged is the risk of taking too many actions, too soon, and for the wrong reasons.

      By Michael C. Thomsett,

      • 0 comments
      • 420 views
    • The Volatility Option Trade In Alibaba

      This is why you have a Trade Machine membership. We can ride the evergreen patterns, and we have, for years. But when the market shifts, we need a minimum amount of data to adjust, and succeed -- now we will. This is our time.

      By Ophir Gottlieb,

      • 0 comments
      • 603 views
    • James Cordier: Another Options Selling Firm Goes Bust

      On November 1, 2018, a money manager named James Cordier from OptionSellers.com published an article on Seeking Alpha named Option Selling Opportunities So Good They're Scary. To me, this title alone would be enough to completely discredit the author and not trust him with my hard earned money.

      By Kim,

      • 10 comments
      • 4,679 views
    • Do You Have a Written Investment Plan?

      Meb Faber recently polled his twitter followers, and found that only about 25% have a written investment plan. Your investment plan should be based on your willingness (risk tolerance) and need (required rate of return to meet your long term goals) to take risk. 

      By Jesse,

      • 0 comments
      • 473 views
    • Options Delta And Other Greeks

      The most worthwhile of the "Greeks" for options trading (and specifically for timing of trades) is options delta. This indicator looks at likely change in option value relative to change in the value of the underlying. The higher the delta level, the more likely the premium will move more than movement in the same direction for the underlying.

      By Michael C. Thomsett,

      • 0 comments
      • 572 views
    • Leveraged Anchor Update

      We wanted to provide a quick update on the Anchor strategy tweaks and improvements. We’ve now been tracking the two different leveraged Anchor Portfolios for close to six months – more than enough time to began a review of performance and make some definitive decisions.

      By cwelsh,

      • 0 comments
      • 505 views
    • The Volatility Option Trade in Apple

      We can ride the evergreen patterns, and we have, for years. But when the market shifts, we need a minimum amount of data to adjust, and succeed -- now we will. This is our time with Apple. It's time to take advantage of volatility. Fear, uncertainty, doubt, unclear news headlines. 

      By Ophir Gottlieb,

      • 0 comments
      • 733 views

      Report Article

    We want to hear from you!


    There are no comments to display.



    Your content will need to be approved by a moderator

    Guest
    You are commenting as a guest. If you have an account, please sign in.
    Add a comment...

    ×   Pasted as rich text.   Paste as plain text instead

      Only 75 emoji are allowed.

    ×   Your link has been automatically embedded.   Display as a link instead

    ×   Your previous content has been restored.   Clear editor

    ×   You cannot paste images directly. Upload or insert images from URL.

    Loading...

    Options Trading Blogs