ETF options give you so many ways to profit from the significant movements in the major sectors, and yet the leverage of options can be a double-edged sword for those who know “just enough to be dangerous.” 

Let’s examine the 5 biggest mistakes I see traders making when it comes to trading options on ETFs, and how you can see these blind spots to improve your own trading prowess.

1) Not having a defined Plan BEFORE you enter the trade

I see many traders who are reacting to market news, the latest rumor or tip, or the biggest jump for the day, hoping to get a piece of the action.  In reality, there are many occasions where the risk a trade might require is simply too high by my standards relative to the potential payoff.  So I pass on a number of ETF option trades if the ratio of reward-to-risk is not at least 2:1, and prefer 3:1 or higher.

When you define your plan in advance, in writing, note what price level will require you to exit the trade … NO MATTER WHAT!  This is called “accepting the risk” of the trade, and the reality of trading is that good traders take their losses quickly while letting their winners run, while poor traders let their losers run too long, while jumping out of their winners for smaller gains (for fear of seeing a winner turn into a loser).  Your written plan should factor in how you will “trail” your stop point as well, so that when an ETF trend does change, you exit your ETF options to capture the remainder of your profits.

2) Focusing just on the Price of your ETF Option

With ETF options, Time is also a very important factor, as are potential changes in the volatility of the underlying ETF. 

One of the key investment themes you must always remember is Opportunity Cost: if you have an option that’s up 20% and another option is up 60%, you have left the 40-point difference on the table as a lost opportunity.  Now, I don’t expect perfection in my own trading, but I do expect to rotate my capital to the relatively better performers, while getting rid of the non-performers as quickly as I can within reason.  Compare this to any business that carries an inventory of items for sale.  If you have items you can’t keep on the shelves, you’re going to want more of those items for future consumption (traderspeak: keep coming back to the stocks that work best!), while items that don’t sell should be cleared out of your inventory (traderspeak: exit non-movers) to make room for future goods that will be in more demand.

As a result, I like to use a “time stop” of 5 trading days for non-movers, on a position I expect to hold for 4-6 weeks.  Even if the option is a slight loss or breakeven but no better after 5 trading days, without violating my price stop level, I will say SAYONARA to the trade and get that capital back to move on to fresher opportunities.  When you get stuck hoping for a move that just isn’t coming, that can often set you up for bigger losses, both in absolute decline risk and also relative opportunity lost.

Full Story: http://tycoonreport.tycoonresearch.com/articles/840073526/avoid-these-major-mistakes-with-etf-options

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