Options trading has become popular with a lot of traders, especially in past few years. While a lot of us do have many Options trading positions based on our trading portfolio allocation, our concentration is always on the price of the underlying whose options we are trading.
They say most of the losses in Options happen due to errors. These errors are nothing but the Risk Analysis that got overlooked while trading Options. While the market is still open, we do keep an eye on our positions. There are multiple means and alerts available to help guide us via our unrealized profit or loss in safeguarding us from committing that error.
However, when we carry forward the position, the situation changes completely. There are 2 factors that come into play - Time and Price. Time that will pass from close today to the open next trading day. Price impact will be the Price that the next trading day opens with. This is important because the price on the next trading day will open after accounting for a lot of information during the closing hours.
This puts us to uncontrollable risk, because Options may behave differently at different price points and different points in time. Hence, Overnight Risk Analysis is essential with 15 mins to market closing with both Price and Time impact. Let us see both one by one.
Time: It is a well-known fact that passage of Time deteriorates the return on bought options due to drop in premium’s time value. (More Time - more time value in Premium and vice-versa).
Detecting Problem: It is not difficult to find a decent option pay-off calculator application over the internet now a days. Plug all your option positions now with 15 mins to market close and check out what your current pay-off across your underlying target and stop-loss is and what would be your pay-off on the day market opens again.
If your pay-off does not deteriorate too much with passage of time, no action. If it does deteriorate significantly (which it could if you have all Option Buy Positions), it makes sense to add Sell position in few strikes Higher Call against Bought Call options or few strikes Lower Put against Put Option bought.
Plug this addition in the pay-off before adding the position and it will definitely help in reducing the negative impact of time value. If it does take that trade.
Price: Price is the one that we all trade and we have our all attention on it but there comes a time when we can not act with overnight movement in price.
Detecting Problem: Here analyze the price gaps the stock/index has posted in recent past. There are ready applications that gives such data or any free charting tool will help you identify the size of gaps that your underlying is capable of.
In similar fashion check your pay-off 15 mins before, if such a gap was to occur on next trading day. If the pay-off does not have an impact with such opening gap price action on up or down side, we are safe.
But if you see an impact on either side, which you may if you have a lot of sell positions in your Options trading portfolio, straight away balance it by Buying similar Higher calls against sold Calls or Lower Strike Puts against sold Puts. At least for overnight this addition will show relief on your pay-off. If it does, take action with still time to spare.
Overnight Risk Analysis and Adjustment is minor yet crucial way to make sure that there are no uncontrollable disasters in Options Trading and that we never lose money to Error of Overlooking.Disclaimer: The views and investment tips expressed by investment 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.