Blog #22 : Factors To Keep In Mind Before Buying Options - Finance With Atul

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Thursday, June 17, 2021

Blog #22 : Factors To Keep In Mind Before Buying Options

 

DO NOT USE OPTIONS SOLELY AS A TIMING TOOL.

It is important to understand that options have a limited time horizon and personally I don’t know of any time cycle analyses which will works consistently. This is because even obvious-looking trends take time to develop but the time clock is always winding down in the options market. It should be kept in mind that to buy options with low volatility so that there is no possibility of loss because of volatility.

 

BUY DEEP IN THE MONEY OPTIONS

As we know by experience that it is always better to buy deep in the money options because each unit gain in the underlying stock or index leads to a higher gain in the option premium. Also, deep in the money options suffer less from time decay as the intrinsic value in such options is high.

 

Blog #22 : Factors To Keep In Mind Before Buying Options

 

ALWAYS BE READY TO ADJUST POSITIONS.

If the market is not acting as you anticipated it would, get out of your options position. The last thing you should do in the options market is hope and pray. Quickly readjust your position with regard to the new market reality but do not over hedge as that raises your investment – remember, there is not risk free trade.

 

TRY TO REDUCE YOUR NET INVESTMENT BY SELLING CALLS WHEREVER POSSIBLE.

This is critical in India because the option has very little time to work. I would go to the extent of saying that it is always preferable to buy a stock or a future and sell calls against them because they do not have any attached time value. Covered call strategies will be discussed later in another article.

 

Strategy To Buy Options

 

 

KEEP A REASONABLE PROFIT TARGET.

I generally believe anything over 50% is a reasonable return in the options market. Unless the market is really trending in one direction, it is worth booking profits as and when more than 50% profits are achieved and move on to next trade. This 50% is the absolute return in a month because that is the time to expiry of Indian options.

 

DON’T BUY MORE NAKED OPTIONS THAN IS JUSTIFIED BY YOUR TRADING ACCOUNT.

It is very important to understand that options market provides the kicker to your portfolio, and this cannot be 100% of your account. Personally speaking, I never keep my account exposed more than 10% to naked option buying.

 

In India the service of culture in the brokerage industries is just about starting. Let go to past, before the mid nineties, there were few brokers and these people didn’t bother a lot about customer services. At that point, just getting an honest broker was considered as being lucky. Now though thing are improving, most of small brokers still like to put the onus of responsibility on the client. As readers, must be aware, in the derivatives market, in each monthly settlement each buy should correspond to a sell, which the broker has to mark as the closure of the position. But this has to be reminded to him that a long or a short position already exists and the second transaction is the closing transactions.

 

 

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