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What is options trading? How do you earn profit from it and what is your strategy

derivatives segment The Derivative Segment contributes to more than 97% of the daily trading of the Indian market, with options forming a significant portion. With increasing market awareness among investors, there has been a surge in retail participation in derivatives segments such as options trading. The main reason for this is high potential returns and low margin requirement. However, options trading involves high risk.

What is Options Trading?

In Options Trading, investors place bets on a possible fall or rise in the price of a stock. You must have heard call and push options. Investors who anticipate a rise in a stock, they buy call options and investors who see a downward trend invest money in put options. In this a term is used and the strike rate is used. This is the price where you see a stock or index moving in the future.

Options trading without knowledge is a game of chance. Most new investors lose money in options. Before getting into options trading, it is necessary to be familiar with some basics. Hemang Jani, Head – Equity Strategy, Broking & Distribution, Motilal Oswal Financial Services, gives a few tips on options trading that may come in handy for you.

Money Required: Options have a very short shelf life, mostly one month, so one should not use the full amount at any point in time. It would be advisable to allocate around 5-10% of the total capital for a particular business.

Evaluate options trades: As a general rule, traders should decide how much risk they are willing to take i.e. have an exit strategy. One has to pre-select the Upside exit point and Downside exit point. Doing business with a plan helps in establishing more successful trading patterns and keeps your worries in more control.

get information: One should try to become familiar with options and some commonly used jargons in their meanings. This will not only help in getting the most out of options trading but can also decide on the right strategy and timing the market. As you progress, learning becomes possible, which increases both your knowledge and experience at the same time.

Avoid Trading in illiquid Stocks: Liquidity is very important as it allows one to get in and out of trades more easily. The most liquid stocks are usually high in volume. Low-traded stocks are unpredictable and highly speculative, so they should be avoided if possible.

Define holding period: Timing plays an important role in the pricing of options. Each passing day reduces the value of your options. Hence the individual also needs to cover the position on time whether the position is in profit or loss.
The main thing is to know when to take profit and when to take loss. Apart from these, one should also avoid excessive leverage and averaging of positions. Like stock trading, options trading involves buying and selling options, either call or put.

Options buying requires a small financial investment with limited risk i.e. up to the premium paid, whereas as an options seller, one takes the opposite view of the market. The assumed risk while selling the options means the loss may exceed the original investment if the price of the underlying stock falls significantly or becomes zero.

There are certain rules to be followed while buying or selling options:

  • Do not buy deep-out-of-the-money (OTM) options just because it is cheaper.
  • Time works against the buyer of the option and in favor of the seller of the option. So buying options near the expiry is not a very good idea.
  • Volatility is one of the essential factors to determine the value of an option. Therefore, it is generally advisable to buy options when market volatility is expected to increase and sell options when volatility is expected to decrease.
  • It is always better to buy options than to sell options before major events or major geopolitical risks.

Keep booking profit at regular intervals or place a trailing stop-loss of profit. Options trading can yield manifold returns if practiced properly.

(Disclaimer: Published views are those of experts. Before investing in the stock market, please consult your investment advisor.)

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