The most successful students I see at Online Trading Academy have knowledge of multiple asset classes and also tend to trade more than one of them. When I ask my students in class, “How many of you trade options?” I usually get several hands raised. However, when I ask how many of them are profitable in trading them, most of those hands go down.
In courses I teach for relationship managers and brokers, I also ask how many of their clients are trading options successfully. To my amazement, I have not found too many profitable options traders in India. This made me look further into the strategies being employed by those traders to see if there is something they are doing wrong and if I could offer a solution.
One such mistake that novice traders make in the Indian option markets is that they try to trade deep out of the money options in order to buy cheap premium. This strategy is often referred to as a lottery ticket as the payouts can be great, but the odds of winning are extremely slim. When trading, we want consistent wins in any market we trade. Most successful traders became that way from winning on a regular basis and not gambling with poor odds to try and make a big win.
Let’s examine that “lottery ticket” trade and compare it to one that has a higher probability of making money. As of this writing, the Nifty has retreated from the 7700 price level. A trader who wanted to take advantage of the potential bearish drop could buy puts. They would profit from a drop in price as well as an increase in volatility by doing this. On the date I am writing this article, the open interest looked like this:
7600 puts = 53,78,800
7500 puts = 57,86,300
7300 puts = 53,67,300
Looking at the high open interest, it appears that many traders are buying their lottery tickets at a strike price of 7300 on the Nifty. But is this the smartest thing to do? Most traders buy this option because of the low premium cost. Looking at the different options, the cost to buy the 7300 put was only Rs. 590.00 (there are 50 shares per contract).
This is a lot cheaper than the 7600 puts (Rs. 3295) or the 7500 puts (Rs. 1900). But is it the best trade? Most option traders ignore the Greeks in trading. The Greeks are measurements of risk in options trading. They can also be used to gauge potential profitability in the trade. Assuming the Nifty is currently trading at 7650 if the Nifty were to move to 7500 at the expiration of 28th August, the trader who bought the 7300 put would profit about Rs. 450 (Rs. 3 per point move in the Nifty). Not bad for an initial investment of only Rs. 590. But wait, holding to expiration would also cost you time value. You would lose about Rs. 33 per day in time value and that would erase all of your profits in the trade!
Buying the 7500 put costs more, but the larger Delta compensates for the loss in time value. The same movement in the Nifty profits Rs. 900, (Rs. 6 per point move in the Nifty), a nice gain for a Rs. 1900 investment. Buy after time has eroded there is no value left as the option expires worthless.
The last trader who bought the 7600 put had to pay the most but gets to participate more in the movement of the Nifty. They receive Rs. 18.35 for every point the Nifty falls. This translates into a gain of about Rs. 1,37,625. There is also time decay but the delta made up for it. Even when time erodes they are left with a gain! The 7600 put finishes with an intrinsic value of 100 points or Rs. 5000 per contract. The extra amount you had to pay at the entry to the trade increased your chances for success in that trade. I think of it as a deposit to make more money in the movement of the Nifty. That 151% gain is a lot better than gambling on a cheap option only to make nothing!
There are a lot of things to learn about trading options. Fortunately there is a solution. Come join us at Online Trading Academy next month for our options course and learn how to trade them properly. Trade smart, it isn’t gambling, it’s speculation with a high probability of success when done right.
Neither Freedom Management Partners nor any of its personnel are registered broker-dealers or investment advisers. I will mention that I consider certain securities or positions to be good candidates for the types of strategies we are discussing or illustrating. Because I consider the securities or positions appropriate to the discussion or for illustration purposes does not mean that I am telling you to trade the strategies or securities. Keep in mind that we are not providing you with recommendations or personalized advice about your trading activities. The information we are providing is not tailored to any individual. Any mention of a particular security is not a recommendation to buy, sell, or hold that or any other security or a suggestion that it is suitable for any specific person. Keep in mind that all trading involves a risk of loss, and this will always be the situation, regardless of whether we are discussing strategies that are intended to limit risk. Also, Freedom Management Partners’ personnel are not subject to trading restrictions. I and others at Freedom Management Partners could have a position in a security or initiate a position in a security at any time.
Editors’ Picks
EUR/USD regains traction, recovers above 1.0700
EUR/USD regained its traction and turned positive on the day above 1.0700 in the American session. The US Dollar struggles to preserve its strength after the data from the US showed that the economy grew at a softer pace than expected in Q1.
GBP/USD returns to 1.2500 area in volatile session
GBP/USD reversed its direction and recovered to 1.2500 after falling to the 1.2450 area earlier in the day. Although markets remain risk-averse, the US Dollar struggles to find demand following the disappointing GDP data.
Gold climbs above $2,340 following earlier drop
Gold fell below $2,320 in the early American session as US yields shot higher after the data showed a significant increase in the US GDP price deflator in Q1. With safe-haven flows dominating the markets, however, XAU/USD reversed its direction and rose above $2,340.
XRP extends its decline, crypto experts comment on Ripple stablecoin and benefits for XRP Ledger
Ripple extends decline to $0.52 on Thursday, wipes out weekly gains. Crypto expert asks Ripple CTO how the stablecoin will benefit the XRP Ledger and native token XRP.
After the US close, it’s the Tokyo CPI
After the US close, it’s the Tokyo CPI, a reliable indicator of the national number and then the BoJ policy announcement. Tokyo CPI ex food and energy in Japan was a rise to 2.90% in March from 2.50%.
RECOMMENDED LESSONS
Making money in forex is easy if you know how the bankers trade!
Discover how to make money in forex is easy if you know how the bankers trade!
5 Forex News Events You Need To Know
In the fast moving world of currency markets, it is extremely important for new traders to know the list of important forex news...
Top 10 Chart Patterns Every Trader Should Know
Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and...
7 Ways to Avoid Forex Scams
The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?
What Are the 10 Fatal Mistakes Traders Make
Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.