In derivatives, options trading is a fascinating activity and it tends to lure investors to try their hands on it. But there are rules in every game and so is in options trading, whether you are a buyer or a seller of an option.
At the Finbridge Traders’ conference 2022, trader-cum-investor and a Youtuber Abhishek Kar explained the nuances of buying and selling options.
An option buyer usually buys because of limited capital unlike an option seller. An option buyer can make limited losses to the extent of the premium paid to buy the option. However, a wrong analysis of the direction or trading strategy could result in heavy losses for the buyer.
As capital is constrained, option buyers typically buy deep out-of-the-money (OTM) options because they are cheap. But if the market is moving against a buyer’s expectation, then premiums of the OTM drop further and he or she loses money, explained Kar.
However, if an OTM put option is bought ahead of any event which suggests that India VIX or volatility index will rise, then an option buyer can make good profit. This is because option premiums rise when VIX rises as it indicates the panic in the market.
Therefore, understanding the movement of the VIX is very critical while trading in options, Kar said.
According to Kar, time is the most crucial weapon for an option buyer. Typically, an option buyer should not hold the position for more than 3 days, because the time decay will eat into the premium.
Kar also recommended retail traders to avoid buying options ahead of a weekend or a long weekend.
So, as an option buyer, the timing and position sizing becomes extremely important. And most importantly, more than hedging, maintaining stop losses is critical, he said.
Finbridge Expo is India’s leading exhibition and conferences, catering specifically to the financial services and technology industry.
(ETMarkets is one of the partners to FinBridge. The traders conference was conducted on Dec 17-18 in Mumbai.)
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)
