Trading Options is both easy and difficult. Easy because in a stock market where 15%-150% is a big move, Options could move in 100% + easily. Option selling is a trading system and has its own benefits and attractions. For now, let us concentrate on Option Buying for beginners. It requires a lot less capital and has a potential for very big returns.
Despite of that a lot of traders do away with Options trading after a few days. The reason is many confuse Options Trading with Stock Trading.
Well, we are trading stocks and indices but with Options like it or not we are trading few more things. What I mean is Stock or Index is a part of Option premium. Option premium (price of Option) has 3 more major components.
1. Time left for the Option to Expire
2. Volatility of the Stock (Expected over the life of the Option)
3. Strike Price Selection (Price at which the Option is exercised).
The 3 tips are around these 3 inputs of Option Premium calculation. If we make way for these elements, who knows for a beginner or intermediate the Option Trading become much easier.
Tip 1: Adding Time Stop Loss on Options
The input of time in Option premium calculation is directly related to it. As time passes the value of premium reduces if the stock and its volatility were not to change. Hence, we should expect some reduction on Option premium on everyday basis regardless of anything.
This will not affect if it is a day, two or even three. But in my experience impact of time in 3 days or more can reduce premium to the extent that it has visible impact. So, 1st tip is to add time stop loss of at the most 3 days on any Option bought.
Tip 2: Beware of Volatility Expected
Just like time even expected volatility has direct relationship with Option premium calculation. This means that if there is an event of result or a policy decision in the next few days, the expected volatility will be higher than normal. As a result, Option premium will also be higher than normal.
Similarly, once the event is over, the expected volatility will drop to normal hence the Option premium will also drop.
Tip here is Buy Option before event and exit also before the event. If one is going to Buy an Option and hold it through the event, accommodate for the drop. This means that one should be okay to risk losing the entire premium. Ther rewards may be sweeter too.
Tip 3 Strike Price Selection:
We all know Options come with different strike prices. What is important to know is that different strike prices behave differently with every 1 Rupee move in the stock.
Higher Strike Calls and Lower Strike Puts compared to current market price move lesser as compared to stocks. They are also much cheaper.
Tip here is choose Strike closer to current market price to get the most benefit of the Option trading.
Disclaimer: The views and investment tips expressed by experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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