9 Weeks to Better Options Trading: 5 Rookie Mistakes to Avoid Like the Plague
Veteran options trader Steve Smith identifies five pitfalls that options traders need to know about -- and avoid at all costs.
4. Ignoring the Power of Compounding Small Gains
Above, we referenced the risk in swinging for the fences with options. The less-sexy – but far more lucrative -- reality is that the best options traders grind out steady profits using a wide variety of strategies, looking to consistently earn 2% to 4% a month, with an occasional kicker from speculative bets.
Two percent per month doesn’t sound like a lot, but compounded over a year, it adds up to 27%. That’s more than three times the average historical return for the S&P 500 (INDEXSP:.INX). Stretch that monthly gain from 2% to 4%, and the annualized profit is on the order of 60%
The important takeaway here is not the idea of making 60% in a year, but rather the power of consistently hitting high-probability singles rather than swinging for low-probability home runs every time we step up to the plate.
Extreme risk-taking could mean that you’re up 100% one month -- and down 50% the next. You do that and you’re right back where you started, but with an ulcer and heart medication.
There is plenty of room for speculation with options, but to stay ahead of the game, you have to pick your spots wisely.
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