Editor’s Note: Options trading is an exciting but complex strategy that offers the potential for significant profits. However, for beginners, this arena can also be a minefield of potential missteps.

Among all the pitfalls, the most common—and perhaps the costliest—mistake made by rookie options traders is focusing solely on short-term, high-risk trades, often neglecting risk management. Below, I examine this all-too-common phenomenon and how to avoid falling into the trap.

Chasing Quick Profits

Many new traders are drawn to options because of their leverage. A small move in the underlying stock can lead to massive percentage gains in an options contract. The appeal of quick wins tempts some traders into buying out-of-the-money (OTM) calls or puts that are close to expiration, hoping for a sharp move in the stock to deliver a windfall.

While it’s true that OTM options are cheaper and can produce outsized returns, they have a low probability of success. More than 70% of options expire worthless, meaning traders who regularly chase these “cheap” options often find themselves on the losing end.

This strategy is akin to gambling rather than disciplined investing, and it disregards the probability factors that experienced traders always keep in mind.

Why Short-Term Options Are Risky

The lure of a big payout blinds neophyte traders to the risks that come with short-term options. These contracts decay in value rapidly due to time decay (also known as theta). As an option approaches its expiration date, its value diminishes—especially if the underlying stock price hasn’t made a significant move. Time is literally working against the option holder.

Short-term options also tend to be more volatile, as small market fluctuations can have an outsized effect on the contract’s value. New traders, unfamiliar with managing this volatility, can quickly see their investments wiped out.

Neglecting Risk Management

The second part of the common blunder is the failure to implement proper risk management. Many beginner options traders invest too large a portion of their portfolio in single trades, hoping for a big payout. When those trades go wrong—which they often do in speculative short-term strategies—rookies can lose a substantial part of their capital.

Experienced traders, on the other hand, manage risk by sizing their trades carefully, using stop-loss orders, and diversifying their option strategies. They understand that not every trade will be a winner, and their goal is to minimize losses when the market doesn’t move in their favor.

The Path to Smarter Options Trading

Novice traders should start by adopting a longer-term, more conservative approach to options. Here are some key strategies:

Use In-the-Money (ITM) Options. These options are more expensive but have a higher probability of success. ITM options have intrinsic value, meaning the strike price is already favorable compared to the stock price, reducing the impact of time decay.

Spread Strategies. Consider using spreads like verticals or iron condors, which involve buying one option and selling another. These strategies limit both risk and potential reward, making them a more controlled way to profit from market movements.

Learn the Greeks. Terms like theta, delta, and vega are critical to understanding how an option will behave as time passes, the underlying stock moves, or volatility changes. Understanding the Greeks helps traders set realistic expectations and manage risk more effectively.

Small Position Sizes. New traders should risk only a small percentage of their capital on any one trade. This way, a losing trade won’t decimate their portfolio, and they can stay in the game long enough to gain experience.

Focus on Risk Management. Always have a plan for cutting losses. If a trade isn’t working out, don’t let hope turn into stubbornness. Use stop-loss orders or exit a position when your loss reaches a predetermined level.

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