Options are an essential tool for the trader. It can potentially turn a profit regardless of market volatility; It can give high returns with low capital required and most options strategies enable you to know the exact risk and profit before trading. But, it is important to know some things for trading in options. Here is a list of do’s and don’ts that you should do before trading options.
What to do
- Know how options work: Compared to stocks and futures, options are a complex instrument. Just knowing the basics of options (strike price, moneyness) is not enough. Knowing advanced concepts (strategies, Greek) will help you successfully trade options.
- Testing: Know that the price of the underlying asset factors such as earnings release, short-term trends and market sentiment. Learning how to do technical and fundamental analysis can help you identify potential trading opportunities.
- Trading with a plan: There are four aspects of a basic trading plan such as entry price ( Entry Price), Stop Loss, Target and Position Size. Create a trading plan that will keep you on track and help you decide what to do when the price moves in your favor or against your expectation.
- Leverage Understand: With options, you can control a large position in an asset with a small investment. If the asset is in your favor, it can bring big profits, but if the asset is in your unfavourable position, it can lead to huge losses.
- Make clear and practical goals: Newbie traders look at options as a get rich quick scheme. However, most successful options traders will agree that learning the intricacies of options trading takes time and effort. Start with small goals and gradually increase your risk appetite as you gain experience.
- Don’t mix investing and trading: Most of the market participants do not separate their short term trades from investments. Trading requires a different mindset and should be in line with short term goals.
- Don’t ignore options strategies: You can buy options. You can sell options. And, simultaneous buying and selling of options is also possible. The strategy adopted by you should be in line with the market conditions. This can help a lot in knowing the amount of profit or loss from trading. You may also have to change strategies in between. This is why it is essential to know and understand options strategies.
- Avoid buying too many OTM options: Options that have no intrinsic value, It is called ‘OTM‘ Or known as out-of-the-money options. Some traders prefer to buy OTM options as they are cheaper and can provide higher returns. However, if there is a huge difference between the strike price and the current market price of the security, then there is a high probability of such options being void. Hence, the trader will incur actual losses.
- Avoid selling naked options: Selling naked options may sound tempting as they promise high profits. But they also carry an equally high risk of loss. Trading using options strategy helps in predicting the profit and loss in advance, and hence, the risk is very less.
- Trading in fixed options Avoid: Fixed options are those which have few buyers and sellers in the market. Failure to do so can result in a large difference between the prices at which people are willing to buy and sell options, known as the bid-ask spread. This can make it more expensive and difficult to buy or sell these options, which can have a negative impact on profitability.
With the above mentioned things in mind, you can start trading your options and increase your chances of success. Patience, discipline and a willingness to learn are key ingredients in mastering the art of options trading.
(Puneet Mahesh is the director of wari ups&zwj. The views published are his personal. Before investing in the stock market, please consult your investment advisor. is for.)