Secret 18BEWARE OF INERTIA

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Another problem with expensive options is that almost all

investors suffer from inertia. When you own expensive options,

you should have a stop-loss price on the underlying stock or futures

price. If that stop-loss price is hit, you should sell your option

immediately.

However, most investors do not use stops and do not like to

take losses. Consequently, when the stock makes the wrong move

or doesn’t move at all, the option trader watches his expensive

option fade away.

As one of my students once said, options (unlike stocks) are

like melting ice cubes. They depreciate as time passes. With stock

you are given a second chance; you can wait for the stock price to

return to profitability. Inertia works in your favor. However, with

options you are not given a second chance. For option buyers,

time is your enemy. If the stock price moves against you, you

must act or you will see the price you paid for that option melt

away. Ninety percent of all investors will not act, and you are

probably in that category.

The big advantage of cheap options is that you have an automatic

stop-loss. If the stock or futures price does not move according

to your predictions, the options will expire and you will

lose the small amount you paid for the option. Then inertia will

not hurt you very much.

Another problem with expensive options is that almost all

investors suffer from inertia. When you own expensive options,

you should have a stop-loss price on the underlying stock or futures

price. If that stop-loss price is hit, you should sell your option

immediately.

However, most investors do not use stops and do not like to

take losses. Consequently, when the stock makes the wrong move

or doesn’t move at all, the option trader watches his expensive

option fade away.

As one of my students once said, options (unlike stocks) are

like melting ice cubes. They depreciate as time passes. With stock

you are given a second chance; you can wait for the stock price to

return to profitability. Inertia works in your favor. However, with

options you are not given a second chance. For option buyers,

time is your enemy. If the stock price moves against you, you

must act or you will see the price you paid for that option melt

away. Ninety percent of all investors will not act, and you are

probably in that category.

The big advantage of cheap options is that you have an automatic

stop-loss. If the stock or futures price does not move according

to your predictions, the options will expire and you will

lose the small amount you paid for the option. Then inertia will

not hurt you very much.