What to not do when trading Options?

Short Answer

Options trading offers many options to traders, investors as well as hedgers. There are some common mistakes that option traders commit. Five of the most common mistakes are, taking too much leverage, not having a pre-defined stop loss and target, acting on tips on social media, adhering to buying options, and taking unhedged trades.

Detailed Answer

What should you not do in Options trading?

Options are derivatives tools that can be used by traders, investors, as well as arbitrators. Options are essentially a contract between the buyer and the seller to exchange the underlying security on a particular date and at a pre-defined price. Options are very effective when it comes to hedging your portfolio or speculating on a particular stock or index.

The leveraged nature of options makes them extremely risky and extremely profitable simultaneously if done right. Options trading requires a good amount of skills and experience. Therefore you shouldn’t start trading in options if you are a new entrant in the stock markets.

5 Mistakes that you should not do while trading options.

1. Don’t trade with too much leverage

Options are already leveraged products, on top of which many brokers provide an additional 5 to 10X leverage. This eventually means you are taking an exposure of 1000 with a capital of 100. This is good if you are capable to generate consistent profits. Even a 10% gain on the capital of 1000 is equal to making 100% on your initial capital.

Although this sounds extremely tempting, remember leverage is a double-edged sword. If your position goes against you and you lose 10% in a trade, your whole capital will be wiped off. Hence, it is best to take calculated bets and utilize only the margin that you truly need and can manage.

2. Have a predefined target and stop-loss before you initiate a trade.

Options trading is not a linear process. Various strategies require you to hold your trade for more than a week or month. In this case, you should have a predefined stop-loss and a target for all your positions. Even if there are no existing rules to place your stop loss and target. Ideally, you should not risk more than 2-3% of your entire capital in one trade. At the same time, you should also ensure you don’t utilize more than 15-20% of your capital in one trade. These are some of the very basic principles which you should refer to when figuring out a stop loss for your trade. On the other hand, your ideal target should be at least twice that of your stop loss. In terms of ratio, your Risk to Reward should be a minimum of 1:2 to become a profitable trader.

3. Don’t execute naked (unhedged) trades

Options trading consist of two parts. One is Options buying and the other is Options selling. Options strategies are usually formulated with a combination of both buying and selling. This not only reduces the overall risk but also increases your winning probability. Trading naked options have it's now benefits such as higher rewards, but on the flip side, there is much more downside associated with it.

Naked option selling exposes the options seller to unlimited risks whereas the maximum profit is capped. Similarly, unhedged positions require more margin money or upfront capital as compared to hedged strategies. This is because SEBI provides more margin benefit for hedged positions as the maximum loss is capped.

4. Don’t act on tips or calls on Social Media or Television

Every day, there are many new entrants in the stock markets looking for making a quick buck on the side. These investors and traders look for quick tips to make some money but fall prey to the so-called market gurus from social media. Many individuals exploit the interest of newbies by providing trading tips and calls to make money for themselves.

These tips might have a vested interest or hidden agenda which you don’t know. Hence, it is important to not fall for these tips and instead learn and analyze the markets on your own. There is a plethora of good-quality content available on the internet that you can access for free. You can use these to your advantage and apply them to do your own analysis which will help you to stay ahead of the masses.

5. Not adhere to only buying options

Small retail traders are often drawn towards Options buying because of the minimum capital requirement. You can buy an option for as low as Rs 1,000 but you need a minimum of Rs 80,000-90,000 to sell an options contract. Many small traders don’t have sufficient capital to sell options hence they adhere to buying options. Buying options may look like a lucrative option but there is a reason why they are so easily accessible.

The probability of making money by buying options is extremely slim. The chances of winning by options buying are merely 33% whereas the chances of winning by selling options are 67%. Due to this reason, most options buyers lose the majority of the time. The limited risk and unlimited reward proposition seem to be intriguing, but the actual reality is different. 95% of the OTM (Out of The Money) options expire worthlessly. This means if you had bought an OTM option and held on to it till expiry, there is a 95% chance that you will lose money.

These were the 5 most common mistakes which options traders make. If you are able to successfully avoid these mistakes, you will automatically increase your chances of being a profitable options trader.

Tagged With: options buyingoptions sellingoption contractsoptions tradingderivatives
Categories: Option Trading
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Related FAQs
Which is better platform Sensibull or Opstra for Option Traders?

If you're looking for a straightforward and comprehensive take on options trading, then Sensibull should do the job perfectly. However, if you're and expert and want more complex trading tools, then Opstra is the one to choose.

Why is Options Trading considered risky?

Options trading is different from traditional share trading in many ways. Trading in options includes multiple factors like high leverage, delivery obligation on the date of expiry, unlimited loss potential, etc. All these factors make trading in options riskier.

What will happen if I don't square off my Option contract on trading day?

If you forget to square off your option contract at the end of the day, the contract will automatically be settled if it's an in-the-money option. The contract would be settled on the expiry date and will be sold at the market price.

How to become a profitable Options Trader in India?

With the increasing exposure of the stock markets, more and more people are trying a hand in options trading. Options trading have become a lucrative place for individuals to earn money. The reality is certainly different. More than 95% of individuals lose money in Options trading, There are various reasons behind this. Find out the reasons for losses and the steps by which you can be a profitable options trader here.

Can I trade in US Options from India?

Yes, individuals can trade US options from India. There are many platforms as well which allows the individuals to trade internationally, it just depends on them what they are comfortable the most with and prefer trading from.

How much money is required for Options trading?

Options trading involves two aspects. One is options buying and the other is options selling. To buy an ATM option you will require around Rs 10,000 to Rs 25,000 per lot for an Index or stock option. On the other hand, you will require close to Rs 95,000 to Rs 1,50,000 for selling 1 lot of index option. These amounts change with respect to the time remaining to expiry and other market conditions.

How much money do you need to begin Options Selling?

Option Selling requires large capital. Due to this many small retail traders resort to option buying where the margin money required is very less. Although with various strategies you can reduce your overall risk and margin required in Options selling. Know more about how much money is required to start option selling. The difference in the margin money required for selling a naked Option vs Selling a Hedged Option here.

Is online trading safe in India?

Trading in India is completely safe as all the online brokers are registered by SEBI, which is the regulating body that regulates all the trading activities in the country. Apart from this, there are certain external risks involved in trading like Market Risks, Volatility risks, and over-leveraging, etc. These types of risks can be minimised to some extent by hedging but cannot be eliminated completely.

What is futures trading in detail?

Futures trading is an agreement to purchase or sell a particular quantity of a commodity or asset at a predetermined price at a future date. It is quite risky and so it is important for the investors to know about futures in detail, so that they do not end up losing money and time.

What is virtual trade in Sensibull?

Virtual trade is a feature in Sensibull which allows the users to be educated about option trading by trading in real stock scenario with real money. Sensibull will also helps the users to learn about trading in much detail.