In my pursuance to educate option traders and stock market investors especially retail trades in India who do not have much information available online here is another article to know when to buy options, when not to buy options and which strike options to buy.
Please remember I am NOT against buying options. Sometimes the results can be stellar and buying options can be used as a great hedge against selling. I am against buying options ONLY when traders start to speculate. For example buying out of the money call option of a stock just because “they think” its going to appreciate and they “start imagining” they will make a lot of money. That seldom happens. Usually these speculators are the ones who actually win their first or second trade and their journey of losing money buying options start.
That is why I keep writing against buying options while speculating. Use them as a hedge tool, speculate when there is a reason and buy with only the money you can afford. If you stop speculating I bet some good results will follow. Else you will blame yourself and your bad luck for the losses. The real reason was greed and ego which you were never able to control.
Here is one email I got yesterday that tells a story which I do not want any trader to experience when he retires:
I am 65 years old a Retired Govt. employee residing in Hyderabad. I lost 8,00,000 (eight lakhs) in options trading since 2012. Till today I have been losing in options buying.
I want to join your course.
That’s exactly why I opened this website to stop people from doing this. I will keep educating but it is your money and your decision where I have no control.
In view of the above read this article to know which strike option to buy, when to buy plus there are a few more stories of losses.
Traders make silly mistakes again and again. If you love losing money its ok. If no then why are you making such mistakes when you already know the outcome? Here is a list of mistakes I did during my initial days of trading. Please avoid these mistakes.
The worst mistake is buying option. It has an inherent attraction – that is of unlimited profits. Therefore new option traders are first attracted to buying options. They think they can buy options and make unlimited amount of money. In few months they understand that it is not the case. Greed is another reason why option buyers keep buying options. They are in the hope that one fine day they will recover their lost money. That day never comes. They keep losing money month after month, in hope of hitting the jackpot one day. When they lose a lot they stop trading.
Option buying can be compared to a Time Bomb. You are having a limited time. Within that period you have to be profitable no matter what. In other words they are running against time. How many times can you beat time?
On top of that there are so many strike prices to choose. If you buy in the money option you put too much money at risk. And if you buy far out of the money, your chances of making money is small.
So Which Strike Option To Buy? (If you insist on buying)
Don’t buy options at all. 🙂 But if you are dying to buy one – buy at the money (ATM) options. At the money option’s risk reward is much more favorable than any other strike option. You do not put too much money on risk, yet if there is a movement in your favor you make reasonable money. Needless to say why it is the most traded or liquid option strike.
Just because you bought an option and it exploded and you made good money does not mean you can repeat the process again and again. Just because you made money once does not make you a good trader. That was beginners luck. It was a fluke where you got lucky. Real world of trading is very different and difficult. There are bound to be hard times, when you will find it difficult to sail through.
Buying options will take your money everyday. You will bleed slowly. So slowly that you will never know. Even if you hedge – a loss is a loss. Here is one article I wrote a few months back why you will never make money buying options.
Here is one real example:
Someone yesterday called me and said he made 6.9 lakhs profit in one month buying options. So he did a simple math: 6.9*12 = 83 lakhs in one year. He told me that at that time he thought he will become one of the richest man in India in a few years. Poor guy. It was better had he lost his trade.
Do you know how much profits he is in right now after 3 years he made a profit of almost 7 lakhs? More than 12 lakhs loss. 🙂
That means total of 7+12 = 19 lakhs lost in 3 years. (Hey, we need to add the profits he made too because he lost that as well.) Which is also more than Rs. 52,000 loss every month. How many in India get that kind of salary? Like I told, you will bleed slowly never realizing your losses. Finally when you realize and stop, the loss will be unbearable.
When you are in profit – you tend to book profit very fast. Say 10 or 20 points. But when you lose you keep waiting for the stock to reverse, it never does and you lose the entire investment because the option expires worthless.
Tip: Take a stop loss somewhere. Say when the option has lost 25% of its value. Save the rest 75% for the next trade.
Another trader was trying to make quick money buying options because his cousin needed emergency medical help. He told me he lost big time. Well my heart goes out to him. What a gentleman. Not many people try to help their cousin when they need money. But brother you choose a wrong path to make money. In fact in a panic situation or when going through any kind or problems in your personal life you should never trade. Because you are not in the right frame of mind to trade. Don’t you take a leave from your job if you are not well or if you have an important work to do? Why do you think you can trade during those times? Imagine if his options were making huge profits at a time he was in the hospital, but by the time he remembers his trade he is losing money? I hope you get the point.
Does It Mean You Should Never Buy Options? No. There are some situations when you should take calculated risks. This is trading, you are not speculating, you are taking a chance because sometimes, just sometimes, time itself is in your favor.
When Should You Buy Options?
It’s not that you should never buy options. There are exceptions:
1. Buying out of the money options can be a great hedge when you are selling near the money options. It will save you from unlimited risks.
2. When Volatility is at historically low – its a great time to buy. When it goes below 12 – then options become quite cheap. Here you can take some chances. Unfortunately Volatility is currently at 15+ and it looks like its here to stay.
3. IMPORTANT – Timing The Buy: Like I said in my last newsletter – when any big event is going to happen – usually markets will take a trend in anticipation. Too much trading (read speculations) takes place. When this happens it increases the VIX – thus both the call and the put premiums also increase. 10 to 7 days before the event is the correct time to buy options, because you know that for sure VIX will increase. If you are trading a long strangle chances are you will come out profitable. Get out just before the results of the event is announced – whatever is your profit or loss. Say if the media is going to declare it at 11 – you should close your trade at 10 or 10.30 max. If you feel movement may continue – clear most of the lots. Leave only 1 or 2 lots to ride the trend.
Tip: It has to be a major event. Small events do not bother the markets.
Risk management is also very important when you are buying options. Do NOT spend more than 10% of your money in trading account to buy options. If you are lucky you make good money, if not you can take a stop loss and still be left with enough money to trade again.
Other than the examples above its dangerous to buy options.
That’s it for today. Hope it helps and I also hope you listen and save your hard earned money. Do not speculate. PERIOD.
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When was the last time you lost money buying options?
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Dilip Shaw, Founder
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