In India margin requirement for intraday shares trading is large. If you have large capital for margins then intraday trading is beneficial.
Cost wise (in terms of brokerages) both intraday trading and option trading –
- Cost the same at discount brokers
- At full service stockbrokers
- Options cost Rs. 20 to Rs. 100 per lot
- Intraday shares trading costs upto 0.055% of the traded value
You can save a lot on brokerage charges if you do large-volume trading using discount brokers. InvestingExpert stockbroker report lists out top stockbrokers in India with the lowest brokerage.
But that is a waste of resources. You can generate a higher ROI by “Options Trading” at a lower risk as compared to day trading shares. But it requires strategy, learning and patience to get the hang of options trading.
In this article, we will explore various options trading strategies and key techniques for risk management.
Options Trading
Options are derivative products that provide you the right, but not the obligation, to buy (call options) or sell (put options) on a specific asset (such as stocks, commodities, or indices). Options come at a predetermined price (strike price) within a specified timeframe (expiration date).
Options trading can be exciting and potentially profitable. However, it also comes with inherent risks. To navigate these risks and maximize returns, understanding and implementing effective risk management strategies is crucial.
Options Trading Strategies
A. Covered Call Strategy
The covered call strategy involves owning the underlying stock and selling call options against it. This strategy generates income from the premium received while limiting potential upside gains. By effectively managing risk, you can generate regular income while still participating in potential price appreciation.
To implement this strategy, you should:
- Own the underlying asset.
- Sell call options against the asset.
- Select an appropriate strike price and expiration date.
- Monitor the position and be prepared to fulfill the obligation if the options are exercised.
Risk management considerations include setting a realistic profit target, selecting an appropriate strike price to minimize the likelihood of exercise, and being aware of potential losses if the asset’s price declines significantly.
B. Protective Put Strategy
The protective put strategy acts as insurance against potential downside risk.
It involves buying put options to protect an existing long position in the underlying asset. If the asset’s price falls, the put option provides the right to sell the asset at the predetermined strike price, limiting losses.
To implement this strategy, an you should:
- Own the underlying asset.
- Purchase put options to protect against potential downside risk.
- Choose an appropriate strike price and expiration date.
Risk management considerations involve balancing the cost of the put option with potential losses, selecting an appropriate strike price to protect against significant downside moves, and monitoring the position to adjust or exit if necessary.
C. Long Straddle Strategy
The long straddle strategy involves buying both a call option and a put option with the same strike price and expiration date. This strategy aims to profit from significant price movements, regardless of the direction.
To implement this strategy, you should:
- Buy a call option.
- Buy a put option.
- Select a strike price and expiration date.
Risk management considerations involve managing the cost of purchasing both options, monitoring market volatility, and being prepared for potential losses if the underlying asset’s price remains relatively stable.
D. Long Strangle Strategy
Similar to the long straddle strategy, the long strangle strategy aims to benefit from significant price movements.
However, it involves buying a call option and a put option with different strike prices but the same expiration date.
To implement this strategy, you should:
- Buy a call option with a higher strike price.
- Buy a put option with a lower strike price.
- Choose an expiration date.
Risk management considerations include managing the cost of purchasing both options, monitoring market volatility, and being prepared for potential losses if the underlying asset’s price remains within a narrow range.
E. Collar Strategy
The collar strategy combines elements of the covered call and protective put strategies.
It involves owning the underlying asset, selling call options to generate income, and using the proceeds to buy put options for protection. This strategy provides a limited upside potential and downside protection.
To implement this strategy, you should:
- Own the underlying asset.
- Sell call options to generate income.
- Use the proceeds to purchase put options for protection.
- Select suitable strike prices and expiration dates.
Risk management considerations include managing the balance between income generation and downside protection, selecting the appropriate strike prices for the options, and actively monitoring the position.
Risk Management Techniques in Options Trading
In addition to employing specific options trading strategies, implementing effective risk management techniques is crucial.
Here are some key techniques to consider:
Diversification
Diversification is the practice of spreading investments across different assets or sectors to reduce the impact of potential losses.
By diversifying options positions, you can mitigate the risk associated with a single position or asset.
Position Sizing
Position sizing refers to determining the appropriate amount of capital to allocate to each options trade.
Proper position sizing helps manage risk by ensuring that no single trade exposes you to excessive losses. Ideally, you should allocate no more than 10-15% of your total capital to a single option trade.
Stop-Loss Orders
Stop-loss orders are orders placed to sell an options position if it reaches a predetermined price level.
These orders help limit potential losses by automatically exiting a position when the price moves against the desired direction.
Setting Profit Targets
Setting profit targets involves establishing a predetermined level of profit at which you will close a position. By setting realistic profit targets, you can secure gains and avoid potential reversals that could erode profits.
Adjusting and Managing Positions
Options positions require active monitoring and management.
Adjusting positions involves making changes to the options contracts based on market conditions, such as rolling options to new expiration dates or strike prices to mitigate potential losses or capture additional gains.
Risk Mitigation Strategies
Beyond options trading strategies and risk management techniques, several risk mitigation strategies can further enhance risk management efforts. These include:
Time Decay Management
Options experience time decay, meaning their value diminishes as the expiration date approaches. Managing time decay involves actively monitoring and adjusting options positions to mitigate losses caused by declining time value.
Adjusting and Rolling Options Positions
As market conditions change, adjusting and rolling options positions can be necessary. This involves modifying strike prices, expiration dates, or even the type of options to adapt to evolving market trends and reduce risk exposure.
Hedging with Options
Options can be used as hedging instruments to offset potential losses in other investments. By using options to hedge against adverse price movements, one can reduce risk exposure.
Using Stop-Loss Orders
Stop-loss orders, as mentioned earlier, can be effective tools for limiting potential losses. By setting appropriate stop-loss levels and promptly executing orders when triggered, one can protect against significant downside risk.
Conclusion
Options trading offers money making opportunities, but it also carries inherent risks. By understanding and implementing effective risk management strategies, you can minimize losses, protect their portfolios, and optimize returns.
From employing specific options trading strategies to utilizing risk management techniques, consistently practicing prudent risk management is key to long-term success in options trading.
