7 Sins of Options Trading — Part 1


1. Buying options with a lot of money

1. Buying options with a lot of money

The biggest mistake of all times. This often ends up in investors losing a big part, if not all, of their capital. NEVER do this.

People do this because:

  1. They think they can make some quick money
  2. They lost big money in other trades, and now wants to make back all the money in one go

It is more dangerous with out of the money options. They are unlikely to make money. They can expire worthless, and a trader can lose all the money.

Take some time and read the above two points again. We all have been here.

How do you get out of this mentality?

Trading is a business. Businesses grow steadily and consistently. Treat your portfolio like a business which has to grow steadily without taking the big risks which can shut it down. Sure, with aggression, James Hunt won a Grand Prix. But it was Niki Lauda’s consistency which went on to win him three of them.

What is the solution?

Do not try making a jackpot with a single trade. Never put more than 5–10% of your trading capital in buying options.

2. Not Calculating the profit and loss

Most Traders think:

“If I buy call options and market goes up I will make money”

“If I buy put options and market goes down I will make money”

They cannot be more wrong than this:

There are two crucial things which option value depends on other than the stock price:

  1. Implied Volatility
  2. Time to expiry

You bought NIFTY 10100 call on a Monday with 10 days to expiry when NIFTY is at 10000. 5 days later on Friday NIFTY is at 10050. Assuming IV did not change, did you make money or lose money? Find out!

No one should trade without knowing the answer. One has to clearly know what the option price is going to be at a NIFTY level on a particular day.

What is the solution?

There are tonnes of Black-Scholes Calculators online. If you want to see and analyse the Option prices at different points of spot price and time do try Option Trade Analyser by Sensibull

Takeaway:

Always analyse the profit and loss of your options trade. If you are buying or selling an option with a view like NIFTY will go to 10200 in 5 days, go to a calculator and see what happens to the option price when that happens

3. Ignoring Implied Volatility

Implied Volatility is the most important variable in Options Trading. Option Traders are called Vol Traders for this reason.

You bought NIFTY December 10000 Call on Monday. Wednesday is the RBI policy. Here is some data

NIFTY December Future = 10020.

Days to Expiry = 10

IV of 10200 Call = 18%

On Thursday, after the policy, the NIFTY December future is at 10080. Did you make money or lose money?

Hint: After the event, volatility usually falls 2–3 points, from 19% it will go to 16% -ish. Try to answer this using a calculator.

Takeaway:

Buying options at a high implied volatility, especially before events can lead to losses because options lose value when the volatility falls rapidly after the event

Solution:

Avoid buying high volatility options. And look out for events

You can see the implied volatility of all Options in here:

NSE Option Chain by Sensibull

Options Central — Options Screener by Sensibull

To be continued…

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