The biggest mistakes most investors make when starting any new investment can have disastrous effects. It is these mistakes that can be attributed to the failure of most ventures as well. In this article, I will delve into the biggest mistake we see when teaching new traders about options. However, these mistakes do not only apply to options trading and are seen with many failed ventures.
Each month we have live calls where Travis and I will go over trades, review of the Big 3 (three major indices), and then we open up the floor to answer questions from the students.
The last call was a bit different as we reviewed a lot of the templates that we teach in the Success Academy. I was asked an interesting question regarding a trade I was in where I purchased 300 shares of AT&T.
How Do You Purchase Stocks?
The most common way to purchase stocks is to simply call your broker and place an order. Or the order can be placed on a broker platform. With a little more experience, an order can be placed at a certain time to avoid inflated prices. In each of these cases, the stock is typically purchased at the market price at the time of the order.
As an options trader, I will sell a Cash Secured Put at a price point below where the stock is trading. If the stock price drops below that Cash Secured Put strike, I will be exercised and will be the proud owner of 100 shares of the stock or ETF.
What Happens When Things Go Bad?
In this particular case, I was recently assigned to purchase AT&T stock at $38 per share and had to purchase 300 shares. At the time of this writing, AT&T stock has since declined to $32.50 per share, so in essence I have a paper loss of around $1,600. When I was first assigned, I had two options, exercise my rights of my vertical credit spread to turn around and sell the shares at $37, in essence taking only a $300 loss. Or, option two was to keep the 300 shares and sell the other option for a profit. I chose option two.
The question I was asked is why I would want to own a company’s stock that is decreasing in value. It’s a great question that I am sure many would question as well.
This is Mistake # 1 For Most Investors
For starters, we have to define a few things. First, what is the strategy or plan we have when purchasing any investment vehicle, whether it is buying stocks, ETF, mutual funds or even real estate? When investing in anything I want to have a defined plan which will help eliminate any decisions based on emotions. This is often the biggest issue we see students struggle with options trading. Having a plan minimizes this issue.
Mistake # 2
Most of us go into an investment only looking at the profit side. This is a common mistake as that is what most of us are looking for. But, it’s more important to first focus on risk or loss. Once we have determined this, we can plan for it. We will save more money because we won’t make any rash decisions if our investment goes South.
Here’s Some Options
So, in my particular case I had a couple of options. First, because of the way this trade was set up, I could simply exercise rights I had and sell the shares I was forced to buy for a small loss. Or, I could keep the shares and sell off my Put options. I chose to keep the shares as part of a long term trade plan.
My Long Term Plan
Here is my long-term trade plan on this particular transaction. I purchased for $38 and at this time in the market, I have a paper loss of around $1,677. But that is only a loss if I sell it now, which is not part of my investment plan.
Also, my actual paper loss is less than $1,677 because of the premiums I have already been paid. Initially, when I sold my credit spread I was paid $167. Then when I was assigned the shares, I was able to sell the other Put option I owned for $510. If you take that total of $677 and subtract it from $1677, my true “paper” loss is $1,000.
And last, I now own 300 shares of a dividend paying stock. This particular stock pays $.50 per share which means I will collect $150 per quarter or $600 per year. In just two short years, I have erased that paper loss, if AT&T never goes back to $38.
Furthermore, if AT&T does go back up in the future to around $38, I have another strategy I can implement called Covered Calls. To give you an example of the revenue I can generate from a covered call, if I sold a similar covered call at the current trading price for 300 hundred shares I would generate an additional $321 in revenue over a 42-day time frame. This strategy can’t be run all the time, but even if you calculate running this strategy three times a year that’s an additional $900 in revenue. Couple that with the dividend payment and I have the potential of collecting $1500 per year on just this stock. And, the more shares you acquire, the better it gets.
Focus On Risk
So, whether it is the stock market or the real estate market, have a plan that focuses on risk first and profits second. We all love big profits and returns, but focusing on risk first will prevent making a bad decision based on emotions when the trade or investment goes against you. It will also help your decisions to get involved in the investment before you get in. That alone will help you sleep better at night!
If you are interested in learning the strategies I talked about in this or previous articles, you can take a look at them here:https://www.learn-stock-options-trading.com/successacademy.html
I hope this article has helped and feel free to leave any comments you may have. Thanks for reading!
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