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General trading topics Options basics

Checklist for an Option buyer

Trading as an option buyer isn’t an easy game as there are a lot of factors playing out opposite to you,time decay,rate of change of underlying(volatility) are worth a mention.

Still if you follow some rules as part of your trading as an options buyer, you can be one of these very rare successful trader being an option buyer. Here are some of the rules you can consider following in your trading as an option buyer.

  • Trade on the buy side of the options only when you expect a sizeable move in the underlying, As an example if you are expecting just a 20 point move in nifty or 50 point in bank nifty it isn’t a good idea to buy options because there is a less probability of making a profit as the move isn’t at least going to be near to the immediate next strike.
  • Select the right strike price Choosing the right option strike will increase your odds as some strikes will have a faster premium appreciation when compared to others. See our post on picking the perfect option strike for more guidance
  • Avoid buying into far OTM options often You should chose to buy far OTM options (>2% distance from LTP) only in a few rare scenarios where you are expecting big movements and these shouldn’t be traded more frequently.
  • Avoid Illiquid options At times it so happens that you feel you have a perfect view on a stock but when you check its options they are hardly traded, in these cases better not take a position as the risk you are taking here is 100% of the premium paid as in case your view goes wrong there will be no buyers to sell your option.
  • Don’t hold options for too much time in hope Options have a value for time and that can result in a loss for you even if your desired target is achieved but not in the time you expected it to come in, So set a time frame in mind that you are going to allow the position to be open.
  • Have an exit plan It so happens that you buy an option and it starts losing premium though the underlying isn’t moving anywhere but you will be a confused state whether to hold or exit, the best thing to do is have an exit plan before the entry and fix a stop loss level from your entry price where you will exit your position irrespective of anything else. This is aimed at saving the capital as in a few cases option prices so rapidly that you don’t even get the time to exit so it is better to have a stop loss set in your system
  • Book timely profits, Do not wait more Booking profits on a timely basis is very crucial for your success as an option buyer, because option prices tends to cool off very quickly after a move this is because of the rate of change in underlying. option prices will appreciate quickly only when there is a rapid move in underlying. These rapid moves in underlying doesn’t come often and are limited and you should be booking your profit during this rush phase rather than waiting for more because it takes a just few seconds for the option prices to be cooled off.
  • Don’t risk heavy in a single trade This is very important rule to be followed as an option buyer as things can get tempting seeing the low premiums but we should also think of the other scenario that is when we lose it’s 100% of the money we put in that we are going to lose in a matter of few minutes sometimes. So size your option trades by keeping this in mind.
  • Have a limit on the number of trades This is especially required if you are a discretionary trader as there is no system that you are following and you are at freedom to place how many ever trades you want to so there needs to be some boundaries set so that you can limit big losses. This can vary from person to person and can be fixed based on your risk profile but keeping it to < 5 trades a day can work wonders for you. This will also increase the quality of your trades as you give more time before entering a trade rather than taking random entry and exit.

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