Should you start Options Buying with a small capital?
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- Updated On:09-Jul-2021
- Replies:1
Short Answer
Options Buying requires a lot of skills and effort from the trader. It is not easy to generate profits using Option buying. Many factors work against Options Buying. Let's look at some of the factors and find out if it's a good idea to start Options Buying with small capital.
Detailed Answer
Should you buy Options with a Small capital?
Option buying in itself is riskier when compared to Options Selling as many factors work against the buyer of an option. Time Decay is the main enemy of an option buyer. On top of that, the Delta of Options is very low for OTM (Out of The Money) Options.
Therefore in short Option buying is not an appropriate idea with small capital. Let’s look at some reasons why it’s not good to start Options Buying with small capital.
1. Low Delta in OTM Options
Delta is the metric that denotes the increase or decrease in the premiums of options with respect to the underlying. The value of Delta ranges from ‘0 to 1’. This means if the Delta of an option is 0.5 and the underlying moves by 100 points. The option premium will increase by 100 x 0.5 = 50 points. When you buy an OTM (Out of The Money) option the Delta is quite low at (0.1 to 0.3). With this even if your view on the underlying is right there with not be much change in the premiums until the stock/index makes a significant move of more than 1-2%.
2. Time Decay
Traders with limited capital tend to buy OTM options where the intrinsic value of the Option is 0. The premium is for the time value of the option. Time value keeps on reducing with every passing hour. This by default eats into your profits until the underlying gives a massive move in your favor. Therefore, for option buyers, it is recommended to buy an ITM (In The Money) option where there is some intrinsic value. This will prevent the option to expire at 0.
3. Requires Perfect Entry & Exit
In option Buying, you need to plan your entry and exits very precisely. Not only your view of the underlying has to be right, but also the timing of the trade. Options buyers require many skills to become profitable. If you hold on to a losing trade for too long, your Option premium will go down to 0. By this, it is clear that option buying requires a lot of Technical and Fundamental know-how. New traders often lose money due lack of skill and knowledge. Therefore, it is better to gain knowledge and then start to trade in the markets with a sizable capital.
Conclusion
Due to the above-listed reasons Options buying with a small capital is not suggested. Buying far OTM options is the most grievous mistake that retail traders make. The chances of an OTM option turning into ITM are extremely minimal. As is it the chances of winning in options buying is very small. On top of that buying OTM options reduces your chances even sleeker. Hence if you have to buy options, it's better to buy (In The Money) Options where it has an intrinsic value. Instead of using naked option positions, you can create multi-leg option strategies like Spreads, Straddles, and Strangles. Following these strategies will increase your probability of profits.
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