How to Avoid Losses in Options Trading? - Finideas (2024)

Reason 1: Wrong view:

Any traders will make a loss when the underlying moves in the direction opposite to what they had expected. So,

  • A call buyer makes a loss when the price of the underlying goes down and a call seller makes a loss when the underlying price goes up.
  • A put buyer makes a loss when the market moves up and a put seller makes a loss when the market falls.


Do proper research before you form your view about the underlying. You can search the Internet or meet experienced traders or brokers to discuss your view before executing an option trade.

Another way to avoid this problem is to execute combination strategies in options instead of going for the basic strategies like either buying or selling of calls and puts. If you want to know how to create these combination options strategies get in touch with us.

Reason 2: Decay in Time value:

Options lose value over time due to a decay in time value. So, the longer the option buyer holds onto the position the more is the decay in time value of the option, resulting in losses for him.


The combination strategies mentioned above can also help you to reduce your losses arising from time value decay. These options strategies generally involve both buying and selling of options simultaneously.

The time decay results in a loss for the option buyers and the option sellers profit from it. So, when you buy and sell options simultaneously, the time value that you lose in the bought option position will be offset by the gain in time value in the short option position. In this way, your losses can be minimized.

Reason 3: Changes in volatility:

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.


To manage the risk of changing volatility you will need to understand an Option Greek called Vega. It tells us what the change in the option premium will be when the volatility changes. You must learn about Option Greeks to understand the risk-return profile of each option. This will help you to decide whether to enter a trade or not.

Reason 4: Margin shortage:

This is another common reason why option traders make losses. If you face a margin shortage or a mark to market loss after selling an option, your broker will make a margin call asking you to pay additional margins to the exchange. If you do not pay, then they will square off the position and the loss will get booked.


Before executing a trade, you must calculate the amount of margin that will be required and make sure that you have the necessary money available. You must also consider the mark to market margins that you will have to pay if your option position runs into losses.

As a thumb rule, you should keep some extra money available beyond what you have calculated to ensure that you do not face any difficulty in managing your position if there is any margin call

Reason 5: Punching mistake:

if you make any error while sending the order to the exchange then wrong trade will be executed and it will make a loss. So, if you buy instead of selling the option and vice versa, or type in the wrong price or number of lots by mistake, then you will make a loss.


The only way in which you can avoid punching mistakes is to be extra careful while placing the orders. As an example, instead of buying or selling several lots together, you can place multiple orders of a few lots each. You can also check the orders carefully before sending them to the exchange.

Reason 6: Heavy movements in the market:

If you sell call or put options expecting the markets to remain rangebound then you will start making a huge loss if the market makes a sharp move.


The option sellers stand a greater risk of losses when there is heavy movement in the market. So, if you have sold options, then always try to hedge your position to avoid such losses.

For example, if you have sold at the money calls/puts, then try to buy far out of the money calls/puts to hedge your position. These out of the money calls and puts cost little but they will protect your position if there is a heavy movement in the market.

Reason 7: Gap up / gap down openings:

If the market opens sharply higher or lower than the previous day’s close, then option traders make heavy losses.


This problem is also like the one of heavy movement discussed earlier. Hedge your position properly to avoid the risk of gap up or gap down movement in the underlying.

Reason 8: Heavy transaction cost:

You must pay several transaction charges to the broker, exchanges, SEBI, and the government whenever you trade. These include stamp duty turnover charge, transaction charge, exchange turnover fees, brokerage, and taxes. If these charges are high, then you will end up losing more than you earn from your option trades.


To avoid paying high transaction costs you need to find a broker who can give you the most competitive brokerage. So, keep meeting various stockbrokers and understand how much they will charge from you if you trade with them regularly. Soon, you will be able to find out a stockbroker who is ready to let you trade at the lowest cost.

Reason 9: Change in exchange rules and regulations:

These may include a change in the expiry date, dividend, bonus, amalgamation, merger etc. announced by the underlying company, etc. All option traders get affected by these changes and in many cases, these may result in heavy losses for the option traders.


You will always have to keep an eye on the change in the exchange rules and regulations so that we do not get caught off guard. Some of these changes will be within our control and others will be not. For example, if there is a change in expiry date then we cannot do anything about it and must go by the revised expiry date. However, when it comes to any underlying specific changes like dividends, we can keep an eye on the underlying and adjust our trades properly.

To avoid the risks of bonus or amalgamation and merger you can trade in index options.

Reason 10: Liquidity risk:

Liquidity risk refers to the risk that there is not enough buyers or sellers in a particular option, or the bid-ask spread is quite large. When that happens, you will find it difficult to enter and exit your position and incur a huge loss.


To avoid liquidity risk, you need to identify options that have a lot of open interest outstanding. This will ensure that when you try to square off your open position, there will be many traders who will be ready to square off their position by becoming your counterparty. Thus, the trade will happen easily and at the right price.

We hope that by now you have got a fair idea about the common reasons why people incur losses while trading in options and what you can do to avoid such a situation. Trade options with these in mind and increase your chances of earning profits consistently.

This article is for education purpose only. Kindly consult with your financial advisor before doing any kind of investment.

How to Avoid Losses in Options Trading? - Finideas (2024)


How to Avoid Losses in Options Trading? - Finideas? ›

The time decay results in a loss for the option buyers and the option sellers profit from it. So, when you buy and sell options simultaneously, the time value that you lose in the bought option position will be offset by the gain in time value in the short option position. In this way, your losses can be minimized.

How do you stop-loss in option trading? ›

What Is a Stop-Loss Order? A stop-loss order is an order placed with a broker to buy or sell a specific stock once the stock reaches a certain price. 1 A stop-loss is designed to limit an investor's loss on a security position.

How do you handle loss in option trading? ›

How to Recover From a Big Trading Loss
  1. Learn from your mistakes. Traders need to be able to recognize their strengths and weaknesses—and plan around them. ...
  2. Keep a trade log. ...
  3. Write it off. ...
  4. Slowly start to rebuild. ...
  5. Scale up and scale down. ...
  6. Use limit and stop orders.
Mar 11, 2024

What is the 5 rule in options trading? ›

Rule 5: Do not Trade with Borrowed Funds

When you trade with borrowed funds, you will be under tremendous additional pressure. This is because repaying the amount will become very difficult if you incur a loss from your trades. This pressure can make you panic very easily if the markets go against you.

How to avoid time decay in options? ›

It is impossible to avoid time decay when trading options. All options lose money every day as they approach expiration. The rate of decay depends on the days until expiration and the option's moneyness. Time decay, or theta, benefits options sellers and works against option buyers.

What is the 7% stop loss rule? ›

Always sell a stock it if falls 7%-8% below what you paid for it. This basic principle helps you always cap your potential downside. If you're following rules for how to buy stocks and a stock you own drops 7% to 8% from what you paid for it, something is wrong.

What percentage should stop loss be for options? ›

How much to set in stop-loss order? It is common to have such a question one is trading, how much to set in stop-loss order? Most of the traders use the percentage rule to set the value of the stop-loss order. Usually, the one who wants to avoid a high risk of losses set the stop-loss order to 10% of the buy price.

Do most people lose money trading options? ›

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.

How many people lose money in options trading? ›

His agency, the Securities and Exchange Board of India, known as Sebi, says 90% of active retail traders lose money trading options and other derivative contracts. In the year ended March 2022, the latest for which figures are available, investors lost $5.4 billion.

Who loses money when you make money on options? ›

The seller of options wins 95 per cent of the time

Like being the owner of a casino in Vegas, when you sell options, the odds are in your favour. But in the options market you have even better odds than a casino. Practically every option buyer loses money.

What is the 60 40 rule for options? ›

The IRS applies what is known as the 60/40 rule to all non-equity options, meaning that all gains and losses are treated as: Long-Term: 60% of the trade is taxed as a long-term capital gain or loss. Short-Term: 40% of the trade is taxed as a short-term capital gain or loss.

What is the safest option strategy? ›

The safest option strategy is one that involves limited risk, such as buying protective puts or employing conservative covered call writing. Selling cash-secured puts stands as the most secure strategy in options trading, offering a clear risk profile and prospects for income while keeping overall risk to a minimum.

What is the 1% rule in options? ›

The 1% rule demands that traders never risk more than 1% of their total account value on a single trade. In a $10,000 account, that doesn't mean you can only invest $100. It means you shouldn't lose more than $100 on a single trade.

Why is option trading bad? ›

Risking Your Principal. Like other securities including stocks, bonds and mutual funds, options carry no guarantees. Be aware that it's possible to lose the entire principal invested, and sometimes more. As an options holder, you risk the entire amount of the premium you pay.

How to win in options trading? ›

Ans: The most profitable options strategy is to sell out-of-the-money put and call options. This trading strategy allows you to accumulate large amounts of option premiums while reducing risk. Traders who execute this strategy can earn returns of around 40% per year.

How to profit from buying call options? ›

A call option buyer stands to profit if the underlying asset, say a stock, rises above the strike price before expiry. A put option buyer makes a profit if the price falls below the strike price before the expiration.

Is stop-loss necessary for option trading? ›

The decision to trade options without a stop loss depends on a trader's risk tolerance, trading strategy, and market conditions.

Can options losses be written off? ›

Any losses are included in the basis of the remaining position and eventually recognized when the final position is closed. Note: Any loss that exceeds the unrecognized gain from an offsetting position can generally be deducted.

Can loss from options be set off? ›

Declaring your Futures and Options (F&O) loss while filing your income tax return can provide several benefits, including: Tax Deduction: A prime benefit of showing the loss is you may set it off against any other income earned by you. A loss on an F&O trade can be adjusted against all income apart from your salary.

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