Effective Option Trading

Effective Option Trading

Varun Aggarwal 02/09/2018 8
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Option trading is an art. It requires sharp skills to make money. Most traders loose out while trying to make money. It looks easy at times but it is not that simple. Investing with options— an advanced trader will tell you— is all about customisation. Rewards can be high — but so can the risk— and your choices are plenty. But getting started isn’t easy, and there is potential for costly mistakes. Option traders speak their own lingo.

Option trading is similar to stock trading, it requires right selection, timing and patience. 

Trading options is not for your average risk taker. Although there are ways to limit your risk to manageable levels, for those with a significant knowledge base and high risk tolerance there is definitely money to be made. 

The consistent options traders who make money are usually professionals who have been trained to understand all of the following factors:

  • The Greeks
  • Implied and Historical Volatility
  • Hedging
  • Synthetic Positions
  • Liquidity
  • Options Trading Strategies
  • Quick execution
  • Changes in the Implied Volatility Skew
  • Supply and Demand Factors

A full understanding of these factors, in addition to a significant amount of seed capital provides an opportunity to make a tremendous return on one’s investment. Master the list before you commit hard earned capital to the options markets.

Understand each of the Greeks. Understanding how Delta affects the price of the option you are trading and comparing it to the bid/ask spread may discourage you from trading a particular Option. Each and every aspect on the list above is second nature to a professional options trader. If you’re serious about trading options then make sure you are comfortable with the list.

While there are an innumerable number of aspects to options trading, a full understanding of these issues goes a long way to helping meet your goal as a profitable options trader. Paper trading is one thing, finding the appropriate options trading strategy to meet your risk/reward requirements is another.


Check the 1st graph of Reliance Industries Limited above. If you notice something about the price, it gives me a very clear information as to what must be done on reliance stock for trading. If you see, open and high for reliance are the same. Now as a trader, you must watch the price action for the first 15 minutes i.e., 9:15 am to 9:30 am once the market opens. If the open and high remain the same; one can initiate a short trade in futures or cash market and that will give good money by the end of the day trading reliance stock on short side. As you can see Reliance Industries Limited closed the day with 2.79% erosion on the price and closing near the day's low, which would have given good money to the trader who initiated the trade. It gave solid 34 points on the downside.

Let's now understand the same concept trading options. Check this second graph below :


As you can see above, open and low for Reliance Industries Limited 1280 Strike Put is the same and remained consistent for the first 15 mins. As a trader, if you notice any liquid option price doing the same for the first 15 mins after the market opens, you can buy that option and your stop loss should be open-low of that option. As you can see, by the end of the day; put option closed near the day high at ₹52.25 and it would have given good money trading intraday on stock option of reliance.

Similarly, a trader could have also generated a trade on the sell side. Check the third graph below :


If you wants to sell an option and make intraday profit, than identifying such trades can be so good to make money. If you check, stock open and high are same and it remained same for first 15 mins of market open. Seeing this, one could have sold the option with stop loss of ₹37.35, which was days high and by the end of the day, option closed near the day's low. It gave excellent amount of money trading intraday swing.

As you must have understood by my example, whether one would have traded future or one would have bought Put or sold Call, both ways; one would have made money. Sometimes, simple techniques are best ways to make money. But most traders are often blind sighted by fanciful things and loose too much money trading options.

Let's understand another example where we could have bought call and sold put option. Check the graph of MindTree below :


As you can see the price pattern, it suggests a clear trade. Open and low for the stock was the same and still remained the same for the first 15 mins of market opening. So if one would have bought on future or cash, it could give a solid 63 points intraday. If a trader would have made a buy position, he/she must have made good gains. Stop loss for the trade would have been very simple i.e., days open-low price, that was ₹1055. Keeping a stop loss in mind, a trader would have gained good money.

Let's check what happened, if one would have bought the call option for MindTree stock.


As you can see, open-low for 1120 call option of MindTree was same and it remained same for first 15 mins. What happened after that was magic indeed!!! Option price more than doubled. It gave whopping 140% return in single day. Isn't it easy. Again stop loss for the trade would have been the open-low price of ₹20.15. Risk was low, as stop loss was small and rewards are great.

Similarly, check what would have happened if you would have sold the put option of MindTree stock :


As you can notice, open-high are same and remained the same for the first 15 mins. As a trader, selling put option with SL of ₹37.15 was great opportunity to make good intraday gains. Option price diluted by 55.57% by the end of the day, giving good money to the trader.

Similarly, I can give you many examples where this simple trading strategy works and it works like charms!!! If someone trades options with discipline, it is a good mechanism to make money. One must have strict stop loss and your system will give good amount of money on regular basis.

To conclude, remember, option selling is an art. Artist makes money, good traders are good artist who know how to paint their bright future. Keeping the concept in mind, always remember one can initiate a buy trade if after market opens, stock price or option price open-low are same for first 15 mins with stop loss of open-low price. One can also initiate the trade on short side, if open-high remains same for first 15 mins after market opens with stop loss of open-high. Keep it simple and keep making money.

Plesae note: Options trading involves significant risk and is not suitable for every investor. Past results are not indicative of future results.

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  • Justin Perez

    While trading options can be very profitable, it's also extremely risky.

  • Stephen Neal

    Probably the single biggest disadvantage to options trading is time, stock options contain a time value that is constantly decaying.

  • Eric Payne

    Having options instead of being compelled to do something is generally a lot more flexible !

  • Hrishikesh Patil

    Informative

  • Josh Peterson

    Understanding how to use options broadens a trader's horizons and makes him or her a more rounded person.

  • Jatinder Prabhakar

    Very nice sir. It is so informative. You have simple strategies with wide vision. Clarity to see the things in the right perspective. Keep it up. Stop loss keeps losses, even if they are in limit.

  • Derek

    Time decay, also called Theta decay, can also be a trader's friend. If a stock has higher than normal volatility, selling puts against it can be very profitable. As the value of the options decay, you can buy them back at a profit. And if you need a defined risk position, buy a few strikes lower than those you're selling to cap your loss.

  • shobhit goel

    Excellent article on option trading strategy with easy to understand examples, I truly believe if someone follows this strategy as per guidelines suggested in this article can make a good amount of money. Thanks for sharing such good stuff.

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Varun Aggarwal

Finance Guru

Varun is the director of Profit Idea. He is a multi-skilled experienced professional in academics, corporate and administration fields. He has over 8 years of corporate training experience in the field of finance & provides training for CFA, MBA, Stock Market (Derivatives, Fundamental & Technical Analysis) & various other financial subjects. He is also associated with various institutes, boards & banks. Varun holds financial and investment qualifications from Delhi University, Yale University, London Business School, Indian School of Business, Columbia University and IESE Business School.

   

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