Trading call options have an enormous appeal for newbie traders. They can create a lot of excitement due to their perceived benefits: considerable upside potential, limited downside, and general simplicity. However, despite their appeal, some traders still lose money when buying call options.
Are you making one of these 7 common mistakes?
Keep reading our guide, and you’ll learn what these mistakes are—and how to avoid them. Even if you’re a beginner, knowing these common blunders can give you a much better chance of trading call options successfully in bull markets and ending up on the winning side of the curve more often than not.
What Is a Call Option? (Quick Primer)
Call options give the buyer the right (not the obligation) to buy an underlying asset at a specified price (the strike price) on or before the expiration date. Using a call option means that the trader is betting on the asset’s price increasing, unlike a put option, which is a bet that the asset’s price will decrease. Call options are the best way for traders to express their bullishness about specific stocks or other assets.
A good example of a call option is when a trader seeks to profit from an asset that is expected to appreciate in value. AAPL is a good stock to invest in for such purposes, so a smart trader would buy a call on AAPL at $180 and likely make money when the stock increases in value as the price rises.
Why Beginners Love Buying Calls
Aside from making money from assets that go up in value, there are plenty of reasons why traders like buying calls. This is especially evident with newer traders who are still learning the ropes and discovering which strategies or techniques work best for their trading plans.
- Low Upfront Cost—It is significantly cheaper to purchase call options than to buy the stocks outright. For a relatively small, upfront investment, traders can manage a larger position.
- Huge Potential Profits—Beginners like buying call options because they offer the potential for huge returns, but they also carry a significant amount of risk if the trade doesn’t work out. The trader can control a prominent position with a relatively small amount of shares, which puts them at risk for the significant risks involved, but they can also enjoy huge payouts if things work out.
- Simple to Understand—Compared to spreads or puts, call options are much easier to understand because the stock, asset, or security needs to go up in value for the trader to make a profit. While they aren’t as simple as they appear on paper, the general idea of how call options work is an enormous appeal to beginners just getting started.
- Emotional Appeal of “Lottery Ticket” Trades—New traders are generally drawn to buying call options, especially those that are out of money, because they offer the possibility of lottery-like payouts. Traders who don’t fully understand that trading differs from gambling can view OTM options as a great way to enter the trading market, even if it’s for uninformed reasons.
Top 7 Mistakes Being Made When Buying Calls
What are the biggest mistakes that traders can make when buying calls? We’ve outlined them all below to give you a good idea of the blunders you should avoid when you buy call options in your trading sessions.
1. Buying Out-of-the-Money (OTM) Calls with Short Expiry
This is a high-risk strategy that can lead traders to significant losses, with the primary mistake being the trader underestimating the probability of the underlying asset’s price not reaching the strike price before the expiration date. The result of this mistake is that the option expires worthless, and the trader loses their premium.
The aspect of this trade that is enticing for some people is that it doesn’t require a significant capital commitment to enter. However, there is a low probability of profit. You have a significantly better profit potential when dealing with ITM or ATM options. A few other factors working against the trader with this setup is the time decay factor, where short-dated options decrease rapidly in value as the expiration date approaches.
Better Approach: Use more realistic strikes or give the trade more time to adjust.
2. Ignoring the Greeks (Especially Delta and Theta)
Understanding delta and theta is highly recommended for new traders who are buying calls for the first time.
- Delta = probability of expiring ITM
- Theta = time decay eats away at the value
Delta shows how much an option’s price will move for every $1 change in the underlying asset’s price, and ignoring it can mean that the trader isn’t fully aware of the directional risk of the position. On the other hand, theta measures how much the price of the option will decrease for every day that it approaches the expiration date. Ignoring theta means that you’re not paying attention to the time decay that’s inherent in any investment you deal with, which can negatively impact long positions especially.
Fix: Learn to read and understand option Greeks.
3. Not Having a Clear Exit Plan
Another major mistake when entering a trading call option is not having a plan in place and basing your decisions on intuition. This leads to disaster unless you get lucky. New traders must enter trading with a clear idea of their profit targets and stop-loss limits, which terminate trading activity once a certain amount of loss has been incurred during the trading session.
Avoid making emotion-driven decisions when trading call options. You don’t want to make trading decisions based on emotions like greed, fear, frustration, or FOMO because these emotions aren’t rooted in a sound trading plan. Traders need to have a strategy based on the amount of capital they have available, loss limits, and conservative position sizes.
Tip: Use price targets or percentage gain/loss limits.
4. Betting Too Big on One Trade
Having the all-in mentality leads to blowing up your account. Trading isn’t like gambling, where a significant portion of the outcome is reliant on chance. It’s a process of thoroughly studying the markets and employing strategies that best capitalize on current market conditions to generate a profit. Additionally, traders must be prudent about the amount of capital allocated to each trade. It’s not advisable to use a significant amount of capital on any given trade—it’s best to keep your traders diversified across various asset classes, industries, and geographies, using small amounts of capital for each position.
Fix: Risk 1–2% per trade max.
5. Trading in Low-Volume or Illiquid Contracts
Traders can make a major mistake by choosing options contracts with low volume, which means there are not enough buyers and sellers dealing with those contracts to make them liquid or easy to buy or sell quickly and efficiently. You want to avoid wide bid/ask spreads, which is basically the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept.
With wide bid-ask spreads and illiquid options comes slippage in order execution, which is the difference between the expected trading price and the actual price executed, which can ultimately change a trader’s profit in the end. Slippage can kill profits, and this is one of the primary reasons why traders should be dealing with liquid option contracts in the first place.
Rule: Stick to liquid stickers with tight spreads.
6. Misunderstanding Implied Volatility (IV)
Traders should keep an eye on the implied volatility levels of the options contract they’re dealing with because it plays a major factor in the entry price that traders can attain. If you buy when the IV is higher, you end up overpaying for the positions, which can cut into your profits for the trade. Ideally, you want to enter the trade at the best possible price, and this is typically achieved when the implied volatility (IV) is low. Prices have fallen rather than being inflated by increased volatility.
Another significant effect that IV can have on the trade’s premium is what’s known as “IV crush,” which happens after earnings reports when IV calms down. This has the potential to wipe out any value the trader has built up, even if the direction is right. It’s just another example of the importance of not misunderstanding IV and the impact that it could have on your positions.
Tip: Learn how IV affects premium.
7. Thinking Calls Are a Sure Bet in Bullish Markets
Don’t make the mistake of thinking that a bull market makes buying calls a shoo-in for a profit. While it’s a good choice, it’s not a sure thing due to factors such as the option contract’s limited lifespan and how theta decay can erode the contract’s value over time.
For instance, contracts can expire worthless if the asset price does not exceed the strike price by the expiration date. While a bull market can help drive the price higher, it may not bring it close enough to the strike, resulting in a loss. In the case of theta decay, the value of the option could erode so far that any gains made by the bullish market pushing prices up are insufficient to overcome the erosion.
There are other scenarios, including stocks staying flat or pulling back, which means that all buyers need both timing and direction to be correct. While it’s likely that a call option will serve a trader well when the markets are on the rise, these investments can still technically lose the trader money. Therefore, analyzing the markets correctly and having a good sense of timing are paramount to the success of the strategy.
Lesson: Even bullish outlooks need careful planning.
Pro Tips for Buying Calls the Smart Way
To give yourself an advantage in buying call options and turning a profit with them, you should check out these pro tips for dealing with these investments in a way that is more carefully planned and well-thought-out.
- Use Longer Expirations—To begin your journey of buying calls and realizing a profit from these investments, start with a focus on contracts that have a longer time horizon, such as 30–60 days. This gives a new trader ample time to secure a profit or pivot their strategy to salvage a losing position. Longer expiration traders are also susceptible to the negative impacts of theta decay because there is a longer period of time to work, during which the prices could turn around.
- Choose ITM or ATM Options—For a higher probability of success in trading call options, choose contracts that are already in the money or at the money. They will cost a bit more to attain, but they have a greater likelihood of resulting in a profitable return than options that are out of the money and still have a long way to go before realizing a profit for the trader.
- Track Market Sentiment and Volatility—If other investors are feeling that a bullish market is on the way in the midst of a bearish market, you could begin buying up call options for companies that are expected to do well once the bull market conditions hit. Keep a close eye on market volatility, as it can help traders time their entry or exit points. Increased IV pushes prices up, while lower IV results in lower prices.
- Start Small—One of our best pieces of advice is to begin with smaller traders and then scale up to a larger amount as you gain confidence with buying call options and understanding the ins and outs of buying and selling. By using smaller amounts in the beginning, you don’t put as much capital at risk, and any losses you might experience when you didn’t know any better would be pretty minimal compared to your money on hand.
Avoid These Mistakes to Trade Smarter
The more familiar you become with the concepts in this guide, the more you can stay away from these simple errors that many options traders have experienced when they first begin trading call options. You don’t want to be the trader who makes a bunch of careless mistakes when a little bit of reading could have enlightened you about some of the most common problems that call option traders make when they are inexperienced.
Once you begin mastering the basics of trading call options, you can skip a lot of the regret that comes from the mistakes, so keep these main principles from our guide in mind:
- Buying calls is a powerful but easily misused tool.
- Mistakes often stem from overconfidence or lack of knowledge.
- Learning to avoid the 7 major mistakes gives you a real edge.
Final Tip: Always trade with a plan—not hope.
