Golden Secrets of Options Trading

So you have been trading in the cash segment but have heard a lot about the magic of options trading?

You would have found numerous articles and videos where traders make options trading look very easy- some also suggest making this a full time profession. But, before you get sucked into the world of options and commit a large sum without knowing the space, take a step back!

According to a recent survey done by SEBI, 9 out of 10 traders lose money on options. However, does that make options a “strict no-no” instrument?

Absolutely not! Let’s understand options like insurance.

Imagine this scenario: You pay a premium of just ₹5,000 for a ₹10 lac health insurance policy. In the very first year, if you encounter any medical needs, the insurance comes to your rescue. Financially, it’s a remarkable win for you. You’ve only paid ₹5,000 out of your pocket, and in return, you receive a benefit of ₹9.95 lac. The medical expenses totaling ₹10 lac are covered by the insurance company. It’s like receiving a ₹10 lac benefit by paying only ₹5,000. Incredible, isn’t it?

However, if you believe you can jump right into trading options by following this example, you are mistaken. Let us look at some of the tips and tricks that professional options traders employ when developing an options trading position. 

Let’s go over a few things you should know before trading options:

1. Premium Spread: Typically, option premiums for the upcoming week or next series expiry are illiquid. Traders tend to avoid trading these options, unless they require long-term price hedging. This is because far expiry options have a narrow spread, making it challenging to find optimal entry and exit prices.
2. Avoid Deep OTM, ITM Options Trading: Deep out-of-the-money (OTM) and in-the-money (ITM) options, particularly for stock options, are usually illiquid and may trade above the theoretical price, resulting in potential losses on the trading day itself.
3. Hedging with Options: HNI investors, institutions, and mutual funds buy PUT options to hedge their portfolios in case of a sudden drop due to global or other reasons. This is why a PUT option will always command a higher premium than a CALL option if both are equidistant from the SPOT price. 
4. Breakout based Options Trading: Options trading is a preferred choice for traders using technical or mathematical breakout-based trading models. With numerous hedging options, lower costs, and greater risk management choices, options provide an advantageous alternative to futures segment trading.
5. Hedged Pair Trading: Strategies like bull call spread, bear put spread, Butterfly, iron fly etc are now extensively used even by retail traders as they give a mental peace of limited loss when selling options and the benefit of Time value on their side
6. Covered Call: This is the most common strategy used by institutions, HNI traders and even mutual funds. Ex : I have 4000 shares of INFY currently trading at 1300, I it will not go beyond 1500 in this expiry I will sell 10 lots of INFY, with an aim to eat premium and even if INFY rises beyond 1500 I will be in no loss as I have the underlying contract in my demat account.

Professional traders employ various tips and tricks when trading options. In our upcoming blogs, we will delve into more strategies. However, a common question among traders is whether to buy or sell options.

To put it briefly, naked option writing carries the risk of unlimited losses, while option buying entails the challenge of time value working against you.

If you are new to options trading, we recommend starting with option buying for your next 50 trades (at least). After gaining experience, you can explore option selling with a proper stop loss (SL) or within a pair trading model where the risk is limited.

Happy Trading!