Options is one of the most commonly traded derivative in India. Speaking of definition – Options gives you the right but not the obligation to buy a particular index or stock. Although it is a very simple instrument, earning from it can be quite tricky.
So here are a few points which you may want to keep in mind.
Never ever go Positional in Options
When you enter options, trade with a mindset that you will complete the trade within 3 working consecutive days. The reason why I used ‘working consecutive’ is because of the time money value factor.
Let’s say if Thursday is an expiry for Bank Nifty Options and you enter a trade on Friday, chances are it will lose its premium on Monday. As the instrument sheds its value on Saturday and Sunday.
Hence it is advisable to trade options only between trading days.
If possible Sell, don’t Buy
This is an amateur mistake made by traders. In fact, I also made the same mistake. Always Sell an options rather than Buy. The reason is again the time value factor.
Let’s say the expiry month is from 1st June to 30th June. A Call Option that you might have bought for Rs 100 might have no or negligible value on 30th June. But if you had Sold or Shorted a Put option for Rs 100 (rather than buying call) and if the value might have turned NIL, you might have gained Rs 100.
Options are usually Bought when people expect volatility in Short Term while it is usually Sold when you know what is the price going to be by the month end.
However, don’t forget this rule. Call Options have Limited Risk, Unlimited Return while Put Options have Unlimited Risk, Limited Return.
Also remember that Selling an options requires more margin while buying an options can be done with relatively small amount.
Make sure traded Options have enough Volume
Another novice mistake made by people. If a stock is trading at Rs 500, how can you buy an option with a strike price of Rs 600. Obviously it is going to have little to no volume. If bought you might not get your price or perhaps you might have to settle for a loss.
So try and buy options that have high Open Interest and High Volumes.
Know when to trade In the Money and when to trade Out of the Money
Without knowing which option to Buy (In the Money or Out of the Money) you will be like an army man blind folded in a war. You will not know what hit you till the time you loose everything. So, remember this –
In the Money – When the expiry is near and you are confident of the market movement buy an option with maximum relative volume.
Out of the Money – When you are not sure of the market movement but you are confident that market will not crash or blast significantly, sell an option which is Out of the Money.
In case you are buying, then make sure to sell it within 2-3 working days (avoid buying in expiry week).