How many times have you bought or sold an option, and been right in the direction which you thought it would go… but you still lost money on the trade?
One of the biggest mistakes an options trader makes is not taking into account whether that option’s current implied volatility is high or low for that option…
If the Implied Volatility (IV) is artificially high or inflated because of pending news or earnings for example, then it’s going to take a much bigger move in the stock price for that option to be profitable.
Otherwise, you can still be ‘Right’ in the direction of the underlying stock… but still lose money….
If the option volatility is artificially high, then the options price will also be inflated and it will be much harder to make money on the trade.
For example: Let’s say you had determined that XYZ stock was going up this week, and wanted to capitalize on the short-term upward movement on the stock. To increase your leverage and buying power, let’s say you bought 10 of the At The Money XYZ Call options, representing 1000 shares of XYZ.
The stock breaks out to the upside, and runs 5 points in 3 days. And if you had bought the stock, you’d be up $5000! But you go and check your options price, and it’s only up $1, hardly enough to cover your commissions and the bid/ask spread.
It’s agonizing and frustrating, and sometimes leads people to stop trading options altogether… But what they don’t know (and sometimes never learn) is why they lost money on the trade!
We’ve just put together a new software program that quickly and easily calculates this for you and graphs it in an easy to read format… It’s truly remarkable.