7 Sins of Options Trading — Part 2

4. Not Selecting the Right Strike Price

NIFTY is at 10000. NIFTY future is at 10020. Expiry is in 10 days.

Scenario 1

You think NIFTY future will go to 10090 in 4 days.

Which call option will you buy? 10000, 10050, 10100, or something else?

Return on Investment for options of different strikes

9900 Call performs better than anything else on the list. Almost double the return on 10100 Call

Scenario 2

NIFTY is at 10000. NIFTY future is at 10020. Expiry is 10 days away.

You think NIFTY future will go to 10200 in 4 days.

Which call option will you buy? 10000, 10050, 10100, or something else?

This time, 10300 Call is better than anything else on the list. Almost 2.5 times the return on 9900 Call.

Takeaway:

Executing your view with options is not as simple as buying a call if you think the market will move up. Which strike you select is crucial. A wrong strike can make losses instead of profits, as shown in Scenario 1.

Solution:

Always use a calculator to see the probable value of different strikes at your target price on the target day. Simulate various scenarios. Do some homework before you take that trade! We can help you there.

Try Options Trade Analyser by Sensibull to compare a call and put

Better still if you would like to know the most profitable options strategy from among many strategies including calls, puts, call spreads, put spreads, iron condors, iron butterflies, straddles, strangles, etc, you can use Options Strategies Generator by Sensibull — India’s First Options Trading Platform

5. Not Keeping Track of Events

Scenario 1:

Bank NIFTY is at 25000. Tomorrow is RBI policy. A trader is unaware of this and buys a Bank NIFTY 25000 Call. The following market scenarios can happen:

1. Violent down move because of a rate hike - Losses
2. No move - Implied Volatility will fall when the market does not move. The option will suddenly lose value, resulting in losses
3. Market moves up a little - Small profits. The trader will make money on the move up, and lose money because of fall in IV
4. Big move up - He got lucky, but luck is not a strategy.

Scenario 2:

Bank NIFTY is at 25000. Tomorrow is RBI policy. A trader is unaware of this and he sells a Bank NIFTY 25000 Call. The following scenarios can happen

1. Violent down move because of a rate hike - Profit
2. No move - Implied Volatility will fall when the market does not move. The option will suddenly lose value, resulting in small profits.
3. Market moves up a little - Small losses. The trader will lose on the move up, and make money because of fall in IV.
4. Market moves up big - Disaster. Trader loses his shirt.

Losses in Scenario 2.4 is bigger than the profits in any scenario. A smart trader will never take such a risk

Takeaway:

Never bet on events by selling options. You could buy options if the option is cheap enough.

Solution:

There are many online event calendars. Just reading financial news online will make sure that you are not betting on random events.

If you are betting on single stocks, you are taking big risks. The biggest event is the results, where it is not uncommon for a stock to move even 10%. You can keep track of their results here:

Indian Stocks Markets Economic Calendar and F&O Results Calendar by Sensibull