Trading options can be highly risky if done without proper knowledge, but highly lucrative when done effectively. In this brief, we will touch upon some of the ways to trade options effectively.
Long or Buy positions in option:
Options are most effective in terms of giving the best of return on investment and good absolute returns when bought of the strike which is nearest to the current market price to the underlying i.e. At The Money strike.
As Out of the Money strikes (Higher Calls & Lower Puts) are inexpensive but would not make a lot of money, while In the Money Options (Lower Calls & Higher Puts) are expensive, gives lower Returns and puts a lot on stake. Hence, ATM options are most effective to buy for trading.
We all know Options are wasting assets, losing value as time passes by, and hence all the buy positions in options must be taken with time factor in mind.
Along with the price triggers for exiting the trade, one must keep time trigger of anywhere between 2-5 trading sessions. This is important as, without time stop loss, there is a possibility of the underlying hitting the price target but option still may not yield anything.
One of the primary utility of the options is to hedge. As they say, you cannot dig a well when a fire breaks out. So hedge beforehand as options can save from any future loss but cannot undo any existing losses.
For effective trade, hedge in advance and remember like every other insurance hedging comes at a cost. Give away that cost as in turn even if the worst does not happen. This cost would definitely bring peace of mind.
Now a word on selling a.k.a. Writing options:
Selling options entail limited profit and a potential for unknown loss. While the probability would always favour option writers who have enough time value, risk management is utmost important to safeguard from unfavourable pay-off.
Hence, the moment the Premium doubles from the traded price, one shall exit the trade as a discipline. As after that point, the trade is asking for more money than the most it could give.
Aforementioned are some of the basic rules to trade options effectively. The most important thing in trading options is to be disciplined and sticking to the rules of the game. It is advisable for users to check with certified experts before taking any investment decisions.