Day Seven: Ten of the Biggest Mistakes in Option Trading
Believing You Can Profit by Trading Overvalued and Undervalued Options
I’ve heard this mistake proffered as advice more times than I can remember. Believing you can profit by buying undervalued options and selling overvalued is a common mistake. At it’s heart is arrogance; a belief that you are smarter than all the other options traders out there.
Statements like this are ludicrous “In most cases, historical volatility and implied volatility will be different, and that’s where the trading opportunities can occur.”
If you are selling overvalued or buying undervalued options you are saying your opinion on future volatility is better than the collective wisdom of the market.
The key to correct for this mistake is to understand that historical volatility is merely a number which represents past volatility. Historical volatility tells you nothing about the future. Conversely implied volatility represents the collective wisdom of all the options traders and market markers. Implied volatility is what they believe is a fair price for future volatility.
As a general rule there are no easy trades in options. There are no free lunches. There are no available option pricing models which will help you become wealthy.
Is it possible to profit to option mispricing? Yes, it is. Market makers and other large professional options tading firms do this by comparing one option to another. They find relatively undervalued and overvalued options by comparing options to each other, not IV to HV.
More: Days one to six in this series of options trading mistakes.
Whole Series: Ten of the Biggest Mistakes in Option Trading
Next Post: Any Suggestions?
Previous Post: Day Six: LEAP into Debit Spreads
Related posts:
- Day Six: Ten of the Biggest Mistakes in Option Trading
- Day One: Ten of the Biggest Mistakes in Option Trading
- Day Two: Ten of the Biggest Mistakes in Option Trading
- Day Eight: Ten of the Biggest Mistakes in Option Trading
- Day Three: Ten of the Biggest Mistakes in Option Trading
- Day Four: Ten of the Biggest Mistakes in Option Trading
Leave your response!