Monday, July 4, 2011

Understand your options

Options are a form of derivative securities. The biggest advantage of options for the retail trader is the ability to trade in markets with a limited amount of investment capital. This advantage can quickly turn into a disadvantage for the under-funded or inexperienced trader. A few bad trades could deplete a small account because of the high leverage provided.

One of the most attractive aspects of options (as well as one of the most dangerous) is that they can provide you with the ability to greatly leverage your money. This is because with an options contract, you can - in effect - control a fairly large amount of underlying value with a relatively small amount of capital.

With the Nifty at 5650, a call option of 5700 strike price is available at 78. The option is available at just 1.3% of the price of the underlying contract. Compare this with the 20% margin required to buy the futures. Traders are attracted to options because of the high leverage provided. But, there is the other side. Option values are affected by Time Decay, Volatility and of course, by the change of price in the underlying. These are complex factors, that can make the option far more riskier than the 1.3% cost.

This post is not written to provide you with a primer on options. Most readers are well aware of the options environment. The Internet will provide you with as much information as you want. The post is to warn you that there is no such thing as a free lunch. Traders should understand the risks of options clearly when trading in them.

2 comments:

rocky said...

Respected sir,
I want to know that what kind of strategy you use while doing intra day as there are n number of strategies available with us which one is more practicable as you know no one can get analyst by reading books, there are also number of automated software available in market it’s just like traveling in auto pilot plane. I don’t think these are worthy if yes then why company pays hefty salary to the pilots, I am not much into day trading so can you share how people does this. what’s the secret behind intra day trading, I feel without having real time software its not possible I have experience ( not much ) buy I can say the people sitting on the head of terminal operator mostly 99% loose money and the people who made money from intra day by the analysis through system. So what are the important factors one must follow so as to succeed in intra day. I have some open positions which I took on some analysis ccan you go through and check if you have time and please comment on it …
Script rate stop loss( closing basis) long/short
Pnb 1111 1111 long
Moser baer 40.5 40.5 long
Bajaj hind 71 71 long
Fortis 164 164 long
Petronet 140 140 short
Ranbaxy 550 550 short

Sasi Uppuluri said...

Sir, Just want to add 2 little points that might save some money for amateurs.

1. Buy calls at good support areas and buy puts at good resistance zones with proper SL.

2. Don't get into complicated strategies available in options trading. You would need them only when you are uncertain of the trend of the underlying.