8 Reasons Why Option Buyers Lose Money | Upstox (2024)

September 14, 2023

Summary:

Different types of market participants trade options for various reasons, depending on their goals, capital availability and risk appetite. This blog takes a look at why option buyers tend to keep losing money and how that can be avoided.

Who invests in options

Different types of market participants trade options for various reasons, depending on their goals, capital availability and risk appetite. Individual investors, institutional investors, market makers, speculators, hedgers, employee stock option holders, arbitrageurs, options traders on stock exchanges and risk managers are among the different types of market participants who trade in options. But what baffles most newcomers is why most options buyers lose money. This blog should help clear things up.

What leads to losses while buying options

Like other forms of investments, options trading carries inherent risks and complexities. Traders should have a good understanding of the options market and associated strategies before participating. Also, options trading may not be suitable for all investors. Options buyers can incur losses for several reasons, primarily related to the characteristics and dynamics of options contracts. Here are some common reasons why options buyers lose money:

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  • Time decay (Theta): Options contracts have a limited lifespan, which ends on the expiration date. As options approach their expiration date, they lose value due to time decay (theta). The closer an option is to expiration, the faster its time value erodes. If the underlying asset's price doesn't move in the desired direction quickly enough, options buyers can suffer losses as the time value diminishes.
  • Lack of price movement (low volatility): Options provide leverage, which means that a small price movement in the underlying asset can lead to significant gains or losses in the option's value. If the underlying asset remains relatively stable or experiences minimal price movements, options buyers may incur losses, particularly if they have paid a premium for the options.
  • Not achieving the strike price (out-of-the-money): In the case of options, there are two main types: call options and put options. With a call option, the buyer has the right to purchase the underlying asset when the strike price is achieved, while a put option gives the buyer the right to sell it at the strike price. For options to be profitable, the underlying asset's price must move in the expected direction and cross the strike price (in-the-money). If the price fails to do so, the options may expire worthless.
  • Overpaying for options (high premiums): Options premiums can be influenced by factors such as volatility, time to expiration and the distance between the current asset price and the strike price. If options buyers pay a high premium for their contracts, they may need a larger price movement in the underlying asset to offset the premium cost and achieve profitability.
  • Transaction costs: Trading options involve transaction costs, including commissions and fees. These costs can eat into potential profits and make it more challenging to achieve profitability, especially for small price movements.
  • Unforeseen events: Unexpected events, such as news releases, earnings reports, or economic developments, can lead to sudden and sharp price movements in the underlying asset. These movements can result in losses for options buyers if they do not anticipate, or react to the events effectively.
  • Holding options until expiration: If options buyers hold their contracts until expiration and they are out-of-the-money (i.e., the underlying asset's price has not moved in their favor), the options will expire worthless, resulting in a total loss of the premium paid.
  • Lack of a clear strategy: Options trading requires a well-defined strategy. If options buyers do not have a clear plan, exit strategy or risk management in place, they may make impulsive decisions that lead to losses.

Minimising losses:

Despite apprehensions, there are ways in which options traders can exercise caution and minimise, as well as mitigate losses. The following are some of the things that can help to not lose money while buying options:

  • Position sizing: Determine the appropriate position size for each trade based on your risk tolerance and overall portfolio size. Avoid overcommitting to a single trade.
  • Use stop-loss orders: Stop-loss orders are able to minimise potential losses. When a specific price is reached, a stop-loss order will execute an exit from the trade if it moves against you. This helps prevent significant losses.
  • Risk-defined strategies: Consider using risk-defined options strategies, such as vertical spreads, iron condors or butterflies. These strategies limit your potential losses to a known and manageable amount.
  • Avoid naked options: Naked (uncovered) options positions have unlimited risk. Stick to strategies that involve both buying and selling options, which can help offset potential losses.
  • Monitor and adjust: Continuously monitor your options positions and be prepared to adjust or exit trades if market conditions change. Have a plan for managing losing positions.
  • Implied volatility: Pay attention to implied volatility levels. High implied volatility can lead to inflated options premiums, making it more challenging to profit. Consider selling options when implied volatility is high and buying when it's low.
  • Time management: Be mindful of time decay (theta) when trading options. Avoid holding options until expiration if they are out-of-the-money, as time decay accelerates as expiration approaches.
  • Avoid speculation: Avoid purely speculative trading without a well-reasoned strategy. Make informed decisions based on analysis, not emotions or hunches.
  • Hedge positions: Use options to hedge existing positions in stocks or other assets. This can reduce the risk of large losses if the market moves against you.

Summing up:

Even though no strategy is foolproof, mitigating the risks associated with options trading requires a solid understanding of options, the use of risk management techniques (such as setting stop-loss orders) and taking into factors such as time decay, volatility and transaction costs when making trading decisions. Careful analysis and research to make informed predictions about the underlying asset's price movements, along with the steps outlined in this blog should help you not lose money when buying options.

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8 Reasons Why Option Buyers Lose Money | Upstox (2024)

FAQs

Why do people lose money in option buying? ›

The value of options increases when the volatility of the underlying increases and it decreases when the volatility goes down. So, if the volatility goes down after you buy an option then the option premium will decrease and you will make a loss.

Why do over 90% of options traders lose money? ›

The futures and options (F&O) market is a complex and risky market, and it is no surprise that 9 out of 10 traders lose money in it. There are many reasons for this, but some of the most common include: Lack of knowledge: Many traders enter the F&O market without a good understanding of how it works.

Who loses money when you make money on options? ›

Option sellers benefit by getting higher premiums at the start due to high time decay value. But it comes at the cost of option buyers who pay that high premium at the start, which they continue to lose during the time they hold the position.

Why do most people fail at Options trading? ›

Why Do Most People Fail At Options Trading? Most people fail at options trading because they have not taken the time to learn how options work and how volatility affects options pricing.

Do option buyers really make money? ›

Options traders can profit by being option buyers or option writers. Options allow for potential profit during volatile times, regardless of which direction the market is moving. This is possible because options can be traded in anticipation of market appreciation or depreciation.

What is the most you can lose if you buy an option? ›

The buyer of an option can't lose more than the initial premium paid for the contract, no matter what happens to the underlying security. So the risk to the buyer is never more than the amount paid for the option. The profit potential, on the other hand, is theoretically unlimited.

How do you avoid losing money on options? ›

Avoid speculation: Avoid purely speculative trading without a well-reasoned strategy. Make informed decisions based on analysis, not emotions or hunches. Hedge positions: Use options to hedge existing positions in stocks or other assets. This can reduce the risk of large losses if the market moves against you.

How much money do day traders with $10,000 accounts make per day on average? ›

On average, day traders with $10,000 accounts can make $200-$600 per day, with skilled traders aiming for 2%-5% returns daily. So, it is possible to achieve a daily profit of $200 to $600 with a $10,000 account.

What is the maximum loss in option buying? ›

If you've sold an option and if the market moves against your position big time, you may have to bring in funds to make good the losses. Now coming to option buying, you are correct. The maximum loss is the premium paid so you can say your capital is the maximum amount you can lose.

How long should you hold options? ›

So, how long should you hold an option trade? Well, it depends on your strategy and your risk tolerance. But if you're looking for a more conservative approach, you might want to consider holding your options for at least 100 days for long positions and 50 days for short positions.

Has anyone gotten rich from options trading? ›

Not everyone can be a successful options trader. However, some can and do get quite rich trading options. Becoming a successful options trader requires a specific skill set, personality type, and attitude, like any undertaking. These are not beyond your reach if you truly desire to learn.

What is the most money you can lose on a call option? ›

The maximum loss is limited and occurs if the investor still holds the call at expiration and the stock is below the strike price. The option would expire worthless, and the loss would be the price paid for the call option.

Why you should avoid options trading? ›

A change in the price or volatility of the underlying asset (such as a stock or index) can cause a large swing in the price of an option. The effect is magnified because the lower price of an option can increase or decrease faster, percentage-wise, for every $1 rise or fall in the asset price (more on that below).

What is the riskiest option strategy? ›

Selling call options on a stock that is not owned is the riskiest option strategy. This is also known as writing a naked call and selling an uncovered call.

How to survive in option trading? ›

5 Options Trading Tricks Rich Traders Wont Teach You
  1. Establish Strategy Dedicated to Options Trading. ...
  2. Understand the Leverage Well. ...
  3. Use Spreads. ...
  4. Always Have an Exit Plan. ...
  5. Pay Attention to Index Options.

Why do option contracts lose value? ›

As the time to expiration approaches, the chances of a large enough swing in the underlying's price to bring the contract in-the-money diminishes, along with the premium. This is known as time-decay, whereby all else equal, an option's price will decline over time.

Why is my option losing value? ›

Options lose more value in the final month before expiration due to increased time decay. Intrinsic and extrinsic values are key components in options pricing, affected by time decay. Understanding time decay is crucial for options traders to manage potential profits and losses effectively.

What percent of options lose money? ›

90% of traders fail to make money when trading the stock market. This statistic deems that over time 80% lose, 10% break even and just 10% make money consistently.

Why is my put option losing money? ›

A put option becomes more valuable as the price of the underlying stock or security decreases. Conversely, a put option loses its value as the price of the underlying stock increases. As a result, they are typically used for hedging purposes or to speculate on downside price action.

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