Retail traders in India are being increasingly drawn to the options market by the allure of making quick profits. The underlying rationale behind this is that the F&O segment can be extremely volatile, so traders have several chances to leverage dynamic price movements to their advantage.
However, this very volatility can work against them. Any unfavourable movement in the market could compound the losses in options trades because most positions are leveraged. It’s no wonder that 9 out of 10 options traders notably suffered losses in FY22.
A closer look at the generally poor trading outcomes for retail traders reveals a crucial problem. Most traders do not use effective options trading strategies. Naked options trading without a clear strategy or hedge in place can be a recipe for disaster. Let’s see why.
The Case for Strategy-Based Options Trading
Disclaimer: We are not SEBI registered. The information provided is for informational purposes only, not investment advice. Investment decisions are subject to market risks. It is advisable to consult a financial advisor before proceeding.
Naked options trading typically involves selling options contracts without owning the underlying asset or having a defensive position. As you may have guessed, this kind of trading has no clear options trading strategy or hedge. Naturally, it can lead to substantial losses, especially in volatile markets.
When you sell a naked options contract, you are exposed to potentially unlimited losses. For example, if you write a naked call and the underlying asset’s price rises significantly, you must provide the asset to the buyer at the strike price. This means you will have to buy it at the current (higher) market price. This price difference can be massive and unpredictable, especially if the market moves sharply against the position.
In hedged options trading strategies, the losses on one side are generally offset by gains on the other. However, naked options lack a safety net because you do not own the underlying asset or hold a counterbalancing option. Without this protection, there is no cap or limit on the risk, so there may be scenarios where losses can far exceed the initial premium received from selling the option.
The leverage effect in options trading also compounds these risks. Options allow you to control a large amount of the underlying asset with a relatively small capital outlay. While this can magnify profits, it also means that losses can quickly escalate and potentially exceed your initial investment.
Additionally, market conditions can also change rapidly. If you do not have a clear options trading strategy, you may not be able to respond effectively to such market movements. This lack of preparedness can result in panic selling or make you hold onto losing positions for too long, hoping for a market reversal that may never materialise.
In contrast, using options trading strategies has a more positive psychological impact too. It prevents you from giving in to emotional responses to market fluctuations — like greed in a rising market or fear in a falling one.
Key Factors to Consider to Find the Best Options Trading Strategy
It’s clear why options trading strategies are important. However, knowing a strategy is crucial and finding a winning strategy are two entirely different things. Building the best options trading strategy for any given market condition, options contract and expiry is an extremely complex process, primarily because you need to factor in a wide range of aspects such as the following:
⦿ Trading Goal
Your goal sets the stage for the options trading strategy and dictates whether you aim to hedge, speculate or generate income. This goal affects the choice of options strategy too. For income, you might sell covered calls, while for speculation, you might buy puts or calls based on expected price moves.
⦿ Market Outlook
How you expect the market to move also influences the options trading strategy you select. If you anticipate an upward trend, you might opt for strategies that benefit from a rise in asset prices, like buying call options. Conversely, a bearish outlook could lead you to buy puts or employ bear spread strategies.
⦿ Risk Tolerance
Your risk tolerance is also a crucial factor in options trading because it affects the selection of strategies that fit your comfort level with risk and potential losses. High-risk tolerance might lead to strategies with unlimited profit potential but also higher risk. In contrast, low-risk tolerance would steer you towards more conservative strategies like using protective puts.
⦿ Trade Timeframe
The timeframe over which you expect your market outlook to materialise impacts the expiration dates you choose for your options. Short-term traders might prefer options with nearer expiration dates to capitalise on quick market moves, while long-term traders might select options with longer durations to give their strategies more time to work out.
⦿ Strike Price
Selecting the appropriate strike price is also an essential part of finding the best options trading strategy. Ideally, it should reflect your market outlook and trading goals. For example, if you expect a significant price increase, you might choose a strike price above the current market level for calls. This offers a higher profit potential.
⦿ Type of Options
Choosing between call and put options is another fundamental aspect of options trading strategy selection. Call options are suitable if you anticipate an increase in the underlying asset’s price as they allow you to buy at a predetermined price. Put options may be better if you expect a price decrease because they enable you to sell at a predetermined price.
⦿ Market Volatility
Volatility impacts options pricing and strategy selection. In high-volatility environments, option premiums are higher, making it potentially more profitable but also riskier to sell options. Conversely, low volatility may favour buying strategies as premiums are cheaper, thus reducing the cost of entry.
⦿ Margin Requirement
The margin requirement is crucial as it determines the capital needed to maintain your position. High margin requirements tie up more capital, affect liquidity and limit the ability to take on other trades. So, you need to assess margin requirements for better risk management in options trading.
⦿ Maximum Profit and Loss
Understanding the potential profit and loss of an options strategy is a non-negotiable part of selecting the best options trading strategy. This insight helps align your strategy with your risk tolerance and trading goals. Multi-legged strategies that incorporate hedging mechanisms typically limit losses to the premium paid, but may also cap potential profits.
⦿ Options Greeks
Options Greeks measure different risks associated with options trading. The Delta assesses how an option’s price changes with the underlying asset’s price, while the Gamma shows the rate of change in the Delta. The Theta represents time decay and Vega measures sensitivity to volatility. Understanding these Greeks helps fine-tune strategies to manage risks and optimise potential returns.
Samco’s Options BRO: A One-Stop Solution to Find the Best Options Trading Strategy
To make it easier for traders to find the best options trading strategy, Samco has introduced Options BRO in the Samco trading app. This is a revolutionary options strategy builder that performs over 1.5 lakh mathematical computations, evaluates 2,000+ strategies and analyses 1,000+ proprietary metrics within seconds to bring you 3 options strategies — one each for aggressive, moderate and conservative traders.
But this is just one part of the story. If you want to explore more strategies that align with your market outlook, you can find hundreds of other alternatives. The Samco trading app also offers various insights for each strategy — including the probability of profit, risk-reward ratio, maximum profit and loss, breakeven price and the Samco risk-reward score.
You can also filter the strategies suggested by the risk level, profit probability, margin required and more. Such comprehensive and agile analytics make it possible for traders to pick the best options trading strategy within seconds and even execute the trade with just one click from the Samco trading app itself. The best part? Samco Securities offers the options strategy builder and all associated features free of cost for users with a Samco demat and trading account.