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Is It Good To Buy OTM Out of The Money Options

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Yesterday I got this email on buying OTM – Out of The Money Options, and I thought it’s a good topic to share my thoughts on this. In this post you will learn whether it is a good idea to buy OTM – Out of The Money Options.

This was his email:

Need your analyses regarding Nifty options

Hi Sir,

I am -name deleted – (CA Student) , I am avid reader of your website articles . I started nifty options trading from last 2 months . it’s actually mock trading but with small amount like RS 1000.

I would like to join your course as soon as I started earning and to my best of knowledge all of your articles are very informative and educative.

Thanks a lot, you introduced me to the best broker in India (greatest platform for all kind of traders in India).

Sir, today I came across a situation where my nifty call option didn’t increase but the next call options was increased .
I will explain in detail.

I bought Nifty July 8900 CE at Rs 5 one lot. At that time Nifty July 8900 CE was 3.75 only. At the end of the day my option was at 5.25 and 9000 CE option was at 6.90.

Literally I can’t believe my eyes. Because 8900 option opens at 6.15 and 9000 option at 4.35. But at the end of the day trading, 8900 option is at 5.25 and 9000 option is at 6.15.

How is this possible?

What is this Dilip Sir? I am looking for true answer. I need your analyses because I believe you.

I am attaching you the screen short also for your reference.

— Name Deleted —-

First of all let me tell you why buying deep OTM (Out of The Money) options is a bug trap to lose money buying options.

What are Out Of The Money – OTM Options?

Out of The Money Call Option is any option with a strike price that is above or higher than the current value or price of the stock. For example at the time of writing Nifty is at 8109. So any strike above 8100 is Out of The Money for Call Options. For example 8150, 8200, 8250, 8300 etc are all right now OTM – Out of Money.

Out of The Money Put Option is any option with a strike price that is below or lower than the current value or price of the stock. For example at the time of writing Nifty is at 8109. So any strike below 8100 is Out of The Money for Put Options. For example 8050, 8000, 7950, 7900 etc are all right now OTM – Out of Money Put Options.

What are Deep Out of The Money options?

Those that are pretty far, so far that chances of reaching that option strike for the underlying stock is nearly impossible within the expiry.

In the above example this person – a CA student, has bought a 8900 Call. So to make a reasonable profit Nifty has to move at least 8300+ within next few days for this option to at least double in value. In fact if it goes till 8900 and does not cross 8900 by July expiry then also this option will expire worthless. All money gone.

So what’s the major problem buying Out of The Money Options?

1. You are racing against time therefore taking more risk. Like an option 10% or more away has 90% of chances of expiring worthless. So in other words the chances of falling in this trade is 90% or more. Why take so much of risk to make money when other better ways are there in options trading?

2. Even if correct if a swift move doesn’t come time will not allow these options to move fast. Assuming a 1% move up comes in 3-4 days but do not forget that there is time value in options that keep eating premiums of all options. So that far OTM options may still show negative return or be in the same place they were 3-4 days back.

3. You cannot compound your money with these kind of very risky and dangerous strategies. This person is taking a risk of only 1000 rupees buying that risky option. If he makes a 10% profit he makes a 100 rupees and if it expires worthless he losses 1000. That is it. But ask him to buy this option for 40-50 lakhs. Even after 10 successful trades his mind will tumble before risking 40-50 lakhs buying a deep out of the money option. For me a trade or a strategy is useless if I cannot compound the profits I make with them and grow my wealth. If you cannot risk 10 lakhs in a trade then even if it is a brilliant strategy it’s a waste of time for me. What will I do with 1000 rupees a month if I cannot increase my trading capacity on that trade?

4. Because risk is more your health suffers: For me health happiness and peaceful living is MORE important than just making money. I should know why I am making money and what are my goals.

To give you an example last week I got a call from someone in Delhi. He is a very successful businessman worth more than 1 crore. Just 12th pass but having more than 1 crore is quite an achievement. He told me he trades Intraday in stocks with 17 computers in a different room. I asked him who looks at his business then? He said there are people who are paid to take care of his business, but he suffers from 9.15 am to 3.30 pm everyday in that room alone with 17 computers switched on with showing those stocks that he trades every day. My next question was obvious – how much profit you make every day. He said one day I make about 10000, next day I lose the same amount. So made nothing in the last 2 years. Then I asked him are you able to give time to your family? He said no. He has a daughter who complains that he never gives time to her. I told him a straight forward thing – you are doing a SIN. If someday you die your kids will not regret because you never loved them, what’s the point you lived or not? Then he said Sir, you have opened my eyes. Thank You. I will give time to them from now onward. My health is also suffering due to constantly watching the monitors and I have become very irritant also. There is no peace in my life.

My next question was – Ok great to hear that, how much money will make you happy? You already have Rs. 1 crore and a great business how much more do you want?

You know what his answer was? Nothing – he kept silent and was not able to figure out how much money will make him happy. Then I told him did you see you were running after something that you do not even know will make you happy or not and you lost the time which will never come back. He thanked me and instantly bought the course.

I hope you got the point – all those who trade Intraday and sit in front of monitors from 9 am to 4 pm (some more who even trade commodity), ask yourself this simple question – is this the way you want to spend your entire life? People who earn less than you but are living a peaceful life are better than you. Because they are more happy in life than you.

I stopped Intraday trading due to this single reason alone. I hated the stress I was getting from it. What’s the point in making money if you think about it 24 hours a day? Are people around you more important or money more important?

Did you notice I did not promote my product to this person to make 5000. I first told him the truth so that he becomes more happy in life and not even once I asked him to pay for my course – but still he paid instantly.

Actually its the same with everyone. I get lots of calls and Whats App messages every day. If I want I can keep an employee, pay him 10000 a month and ask him to call people to buy my course. But I will NEVER do that.

Whoever is enrolling in my course is enrolling out of his own interest not out some phone call marketing. Did even one of you got a phone call back from me asking to buy my course? Once you call me I talk to you give you an honest answer and forget the call. Never call back ever. If you pay fine, if you do not pay still fine. I cannot sacrifice my peace to get money.

Remember this – Peace cannot be bought by money. It is a big myth that more money means more peace – its not.

5. Buying OTM option is NOT trading its gambling: People buy OTM options because they think it’s cheap , and can easily be doubled if a move comes. What they forget is that move has to come in their direction very fast. Even if 3-4 days goes away forget the profits – you will book your losses and come out.

Let me take an example. Assuming you bought a deep OTM option for 5 worth Rs. 5 lakhs. That night you will not be able to sleep well. Next day that option opened at 4. You are sitting at a loss of 1 lakh. You will surly lose patience and book 1 lakh loss and come out – only to see an hour later that the option is trading at 6. You then hit yourself hard for booking a loss. In frustration you buy that option again for 4 lakhs. But within 1 hour that option is back at 4, you again get frustrated and again book losses. This is life of an OTM option buyer.

Time Lost, Money Lost, Frustration Got.

You do not sleep well, you do not talk to people properly due to frustration and you keep losing whatever you made out of a business or job. Is this the kind of life you are looking for? Let’s assume you are a good trader and making 50k a month buying OTM options. But your life is still full of stress, what’s the point of making that money when one day you will give 50% of what you made to the doctors?

Stop gambling please learn to trade. Trading is a business, gambling is not.

Now coming to his question of why deeper OTM option was trading at a higher value?

Please remember that an out of the money option has no intrinsic value, but only extrinsic or time value. As a result, the value of an out of the money option erodes quickly with time as it gets closer to expiry. If it is still out of the money at expiry, the option will expire worthless.

But other factors also come into play. Like the ask and bid prices. There could be less traders on 9000 Call – this is obvious. In that case may be that option was trading at lower level but the best seller quoted a higher price than what the software was showing. Whether anyone traded it or not, is a different issue – but if that is the best seller all buyers will see that price. Now it depends on the buyer to buy or not but since there are no sellers below that price – the software will show that price confusing the buyers like the one who had written to me.

Obviously if buyers are more and sellers less, the sellers will try to maximize their profits so the asking prices goes up irrespective of the real value of the option.

Hope you have understood. If there are more question please write in the comments section.

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Open ZERO Brokerage FREE Share Trading Account - Buy and Sell Stocks Without Brokerage - Set GTT (Good Till Triggered) Orders on System and Forget

Traditional brokers charge a lot for brokerage; however, this broker does not charge anything for stock buying and selling. Also, you can set GTT (Good Till Triggered) order after buying a stock, so that the system can sell the stock automatically at your target price even if you are not monitoring the market. Only 25k is blocked for option selling with hedge. Also, you get a lifetime free account in Sensibull (virtual trading app & strategy builder) which charges Rs.800/-+GST a month. It takes 5 minutes to open an account online. Click here and Open Free Account with Them Today >>

About the author: Dilip Shaw I started trading stock markets since 2007. However my first 3 years were losses. Then I dedicated almost 1 year on studying, researching, paper trading options and learned a lot in that time. Since 2011 I am trading Nifty options profitably. Call me if you need any help trading options on 9051143004.

{ 16 comments… add one }
  • Rangarajan June 28, 2016, 3:08 pm

    You mentioned one lakh option buying in this article . Please tell me about problems while trading one lakh contracts. Is it allowed. Any liquidity problem will arise. Thanks and regards.

    • Dilip Shaw June 28, 2016, 9:14 pm

      Good question. I have no idea if there are any limits on retail traders’ total capacity of trading. But I am sure to protect big fluctuations there must be a limit. May be more than a lakh but frankly I do not have that knowledge if there is a limit. You can ask your broker to know the real answer.

  • ajay June 28, 2016, 7:13 pm

    unbelievable that some one needs 17 computers when he can make a watchlist of all stocks. this can’t be true, absolute lie. a biliionire can’t be a fool that he will run after 1000 daily by skipping crores of business.

    • Dilip Shaw June 28, 2016, 9:11 pm

      I only said what he told to me. How can I know if he is telling the truth or not? I just do not know him. But mostly people do not tell lies to me when they call. But the point of the post is something else – it is please live a peaceful life, trade to make money but do not stress yourself to get that money. Hope my point is clear.

  • CA student June 29, 2016, 1:32 pm

    Thanks a lot dilip .now,I understand the whole concept of OTM.

  • ajay saha June 29, 2016, 6:24 pm

    i love stock market. and i also pay for this.but I don’t mind for this.can u tell me stock or option what is the best for stress less life.

    • Dilip Shaw June 29, 2016, 7:11 pm

      That depends on what knowledge you have plus how much control you have on greed.

  • INDRAJEETH June 30, 2016, 9:36 pm

    Ok Sir,
    OTM like 8900 call are rare to occur ,so can we make small money by writing (selling)the same call . kindly suggest

    • Dilip Shaw July 2, 2016, 10:19 am

      But the risk is very high when Nifty goes against the trade. I do not like low reward high risk trades. But the its your choice.

  • CA student July 10, 2016, 9:17 am

    hi dilip ,
    As you said high risk on OTM like 8900 JUL CALL was right …..Actually my point is post BrExit the same call was around Rs 13. after Brexit it is between Rs 6 to Rs 5 . so lets buy this @ 5(2 lots) and once nifty recovers the same it will come around Rs 9 to Rs 11. as i guess, nifty recovers in 3 days and this call is still around 6 only . now due to last three days of fall in nifty ..it reaches Rs1.5 . but still i am hoping for better . what your comment dilip ?

    • Dilip Shaw July 10, 2016, 11:05 am

      CA Student the first rule of trading is learn as much as possible, second is learn to control greed, third is trade in discipline and proper planning and forth control fear. Looks like you are not following any rules. Can I know why you buy OTM call when you knew the risks involved?

  • Beginner trader July 12, 2016, 11:24 pm

    Hello sir, I am in need of some suggestion. I had bought 8100 and 8200 nifty puts but when market started rallying upwards till 8300+ I bought 8300 put and again to recover my loss I bought 8400 put assuming it to recover my losses if market corrects till 82-8300 levels. But now it’s rising above 8500 . Any thing I can do to reduce my losses? I have around 35000 in these nifty puts. Please suggest as soon as possible.. I am in big trouble.

    • Dilip Shaw July 28, 2016, 11:10 am

      Please understand that markets will NOT move as you think, this is the reason option buyers lose money. Option buying is like buying a lottery. Only one out of hundred times it works – the rest times it fails. When it works its just luck or fluke not because that person is a great trader. You should have hedged your position to limit losses when you took this trade but now since there is no hope you must exit. Today is expiry I am sure if you have still not exited these options will expire worthless. So all your money is gone. Hedging cannot be done later else everyone would have done it only later. It should be done at the start of the trade. So now your only option is to exit that’s all I can say. I am feeling bad but this is the major reason why speculative trading losses money. In future please avoid this.

  • SATYA RANJAN DAS January 12, 2018, 11:46 am

    I have read the analysis on OTM option & understood the importance of time. As understood, if we go for option, we may consider for ATM option. If possible, let me clarify through the following example, how one should take position. Example: M&M is now in uptrend after its bonus issue. Today at 11.45 AM, the price of M&M 760CE is Rs.13.80 & 780CE is Rs.6.10 (january contract). what is the wise trade & what are the probable situation if it holds good 760 in this series.

    • Dilip Shaw January 12, 2018, 1:08 pm

      Depends on the move M&M makes. If you do not want to take too much risk then OTM options is better. But if you are certain of the move go for ATM option as it becomes ITM fast if the moves comes and get into DELTA of 1 for bigger profits.

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