The loss in trading is very common across the segments in the various financial markets. Trading in financial instruments can be risky if the market is highly volatile and you may incur losses if the market does not move as per your expectations. Such unexpected losses not only minimise your chances of profitability but also reduce overall return from the trading.
However, in options trading, the losses could be much higher in comparison to the cash market. And it is not possible to avoid such losses especially when the market is moving unexpectedly or trading with high implied volatility. However, you can recover such losses if you trade with the right approach and follow profitable trading strategies as per the market situation. Regarding this, we have brought here a few tips to avoid and recover losses in options trading.
8 Factors Causing Losses in Option Trading
Before you control or avoid losses, you need to understand the various factors that can cause the losses. Compared to the cash market, in option trading multiple factors affect the price of the option premium, hence understanding these concepts is very important to make sure you can manage the risk from such factors and minimize the chances of losses in trading.
Also Read: What are the Top Factors Affecting the Stock Market in India
1.Unexpected News or Events
The economic news, events and corporate actions, all affect the market movement including the options market. You need to keep an eye on such events or actions that can affect the market movement and can become the cause of losses in trading.
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Consider All the Options Greeks
Option Greeks like delta, gamma, theta and vega affect the option price. If you don’t consider these option Greeks in which with the time decay the value of option premium starts losing as soon as the expiration date arrives that causes the losses if you not exit from the trade position timely.
Also Read: What are the Delta, Gamma, Theta and Vega in Option Trading
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Ignoring the Volatility in the Market
Implied volatility in the market can cause abrupt movement in the price of underlying securities resulting the losses. If volatility is high, the option sellers can lose their money with unexpected movement in the option premium. If the volatility is low and the price of the underlying security is unstable, then option buyer can lose their money.
Also Read: How to Use Implied Volatility in Options Trading: Strategies
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Buying Highly Priced Option Premium
If you bought an option contract at a very high price, the volatility can make the price change with unexpected moves resulting the losses. Hence, buy the option contract at the right premium price to avoid losses and gain the maximum profits in options trading.
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Choosing the Option Strike Price
Choosing the right strike price in option trading is very important to make your trade highly profitable. Buying an options contract with the strike price out-the-money becomes worthless if the market does not move causing the loss of the premium you paid.
Also Read: What is Strike Price in Options & How to Select Strike Price
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Unsuitable Expiration Date
If you buy an option contract that is about to expire or too far away can be worthless if the market condition is stable your option premium can become worthless on the date of expiration. An option contract with price movement can cause you losses.
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Wrong Trading Strategy
If you choose a wrong trading strategy that is not favourable as per the current market conditions, then you could incur huge losses in options trading. Hence, as per the market trend choose the bullish, bearish or sideways trading strategy to avoid the losses.
Also Read: Top 10 Different Types of Trading Strategies in Stock Market
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Lack of Risk Management
And one of the top reasons behind incurring losses in options trading is trading without proper risk management. Yes, you need to trade while hedging your position in case of unexpected moves your losses can be compensated by the multiple trade options.
Also Read: How to Manage or Do Risk Management in Options Trading
10 Tips to Avoid or Recover Losses in Option Trading
Though it is not possible for any traders to recover all their losses, there are various things you keep in mind that will help you to avoid losses in option trading. In respect of the same, you can check below how you can recover or control your losses in option trading.
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Trade with Strict Stop Loss
One of the best ways to mitigate the losses in option trading is always trade with strict stop loss. The stop-loss orders will reduce your major losses if the market or underlying security is not moved as per your expectations. Stop loss-backed orders automatically exit the trade positions if the price moves beyond the stop loss point and helps to protect from unexpected losses.
Also Read: How to Set Target Price and Stop Loss in Intraday Trading
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Follow the Positing Sizing
Position sizing is one of the best ways to reduce your losses in options trading. Yes, you need to decide the quantity and size of the amount you can put at risk for trade. At the time of position sizing, you need to take into account the size and risk tolerance. Also, don’t invest too much in one trade, multiple trade positions help to reduce the losses.
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Don’t Trade without Hedging
Entering into a naked position puts your investment at unlimited risk, especially in option trading where you have alternatives to hedge your trade positions. Trade with both sides of trade positions (buying and selling) to compensate each other if the market moves unexpectedly. In option trading, you can trade with a combination of call and put at the same time.
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Risk-free Trading Strategies
To minimize or reduce your losses in options trading you have to choose the low risk or risk-free trading strategies. You can pick the iron condors, butterflies or vertical spreads that will help you to trade with risk-free trading experience in options trading. However, there are various other trading strategies that give low returns but also have less risk in trading.
Also Read: Short-Term Trading Strategies that Work in the Stock Market
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Keep Adjusting Your Trades
In options trading, if you want to avoid losses you need to keep an eye on your open position and adjust the same to either book some profits or exit from the same if market conditions are not favourable. Meanwhile, in trading, you need to keep adjusting your stop losses and target points as per the latest trend and changing market conditions.
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Trade with the Right Strategy
One of the best ways to avoid the losses in option trading is choosing the right strategy that is not only suitable as per your risk profile but also work as per the current market conditions. You can choose from various profitable option strategies like bullish option strategy, bearish option strategy or sideways option strategy as per the latest trend in the market.
Also Read: How to Identify Trend in Stock Market: 10 Points to Find Trend
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Learn from Past Mistakes
Learning from your mistakes is another way to improve your performance. In option trading, if you have incurred losses or entered any wrong trade position or the market has not moved as per your expectations, then you should analyse what went wrong. Learn from such mistakes that make your trade positions into losses and avoid making the same mistakes again.
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Avoid Overtrading in the Market
The habit of overtrading in the market is one worst practice that indulges traders into huge losses. Yes, few traders despite incurring losses, keep trading whether either market is favourable or not for them. You need to abstain from such overtrading practice. If you have booked profits in a trade position, you should avoid further trading to make your day profitable.
Also Read: How to Stop or Avoid Overtrading in the Stock Market: 8 Tips
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Stay Away from Speculative Trades
Entering into trade positions influenced by your emotions or based on speculations could be very risky. You need to stay away from such speculative trading and instead make decisions on the basis of fundamental analysis and technical analysis. In option trading, analyse every factor that affects the price of the option premium and trade with the right strategy.
Also Read: Technical Analysis vs Fundamental Analysis: Which is Better
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Trading backed by Professionals
Option trading is already very risky for everyone, especially those who are new in the market. Here you need to get help from market experts like derivatives analysts. The market expert will suggest you the right trading strategy with calculations of your payouts while entering into the trade and the potential for profits and losses in various market conditions. These experts will also suggest popular risk management techniques to avoid losses in trading.
Risk Management Techniques to Avoid Losses in Trading:
Research and Analysis: Trading in the stock market is like playing a blindfold game. And in options trading, if do the same you might incur huge losses. Before entering into any trade position you should do proper research and analysis to correlate the various factors that affect the option price. Perform the fundamental analysis and technical analysis to get more precise outcomes of the market and improve your chances of profitability.
Also Read: What to Research & Analyse Before Buying a Stock of a Company
Use the Technical Indicators: In trading either intraday trading or options, technical indicators play an important role in analysing the price movement, its trend and expected movement. You can use various popular technical indicators like RSI, MACD, Oscillator or Bollinger bands that can give the indication of precise buying and selling levels with quick alerts.
Also Read: Best Technical Indicators for Option Trading in TradingView
Avoid Trading in a Volatile Market: Trading in a highly volatile market can lead you to huge losses. As when the market is, volatile or underlying security is moving with huge price fluctuation. It could be risky to trade is such volatile market conditions. However, for option buyers, the volatility can give the right opportunity to trade and for option sellers low volatility is a friend.
Also Read: How to Trade in High Volatile Market: Best Trading Strategies
Diversifying the Investment: Diversification of investment is one of the best ways to protect the assets from unexpected losses. In option trading too, you need to diversify your trade taking multiple positions like in the cash market, futures and optionsto avoid unexpected losses. One asset running into loss, and another asset into profit balances the overall returns.
Hedging-based Trading: Always keep in mind market can move in either side direction. Trading into a side trade position can cost you losses if the market moves against your expectations. The best way to avoid such a situation is to hedge your trade position with both sides' trade positions. And when the market moving one side, you can exit from the other position and wait for a favourable trade position to give you the profits from such a significant movement.
Avoid Trading Regularly: Trading always in the market is not a wise decision, because the market is not always favourable for traders. In option, trading when the market is highly volatile selling the options should be avoided, while in low volatility buying the option is not profitable. Hence, when the market is not favourable don't trade, just stay away from trading.
Also Read: Why Option Selling is Better than Option Buying: Explained
Summing-up
Recovering all the losses in trading is not possible for anyone, but you should learn from such mistakes giving you losses and avoid trading with such unprofitable strategies to minimize the chances of losses and maximize your profitability. And option market is already a high-risk trading zone where most of the traders incur losses on a regular basis.
Also Read: Option Trading or Intraday Trading Which is Better for You
However, if you follow various rules and trade with certain disciplines like trading with strict losses, consider the volatility, hedge your trade positions, avoid over-trading, choose the right strike price, trade with a low fairly priced option premium and trade with the right strategy. Apart from that, you also need to choose the right trading platform to avoid losses.
Also Read: Golden Rules for Trading in Stock Market: Top 10 Basic Rules
You can choose Moneysukh to get free access to the best online trading platform and trade into options and other market segments like equity, commodity and currency. Here you get the advantage of trading with the most profitable option strategies recommended by the market experts as per the changing market conditions. And you will get the facility to trade in options through Algo-based trading software for better profitability and returns in the market.
Also Read: How to Start Algo Trading in Moneysukh: A Best Algo Trading Platform