Options trading is exciting. For all the versatility and flexibility it provides, traders have their fair share of challenges when it comes to trading in options. Let's talk about the most widely faced challenges while trading in options and what you can do to overcome them.
1. Low liquidity: A handful of stocks and select indices are available for derivatives trading in India. Even fewer have the liquidity to encourage trading in options. Traders should only select stocks and indices with enough liquidity to have easy entry and exit. Before entering into any contract, the traders should be mindful while selecting the strike prices because not all strike prices have the same market depth. Indices like Nifty50 and Nifty Bank provide ample liquidity.
2. Time decay hurts buyers: The option premiums shrink as expiry approaches. Option buyers often hold on to trades in the hope of a big swing even when the premiums keep falling. In such trades, the premiums go to zero, and the options expire worthless. Buyers will be better off using strict stop-losses and exiting the positions to salvage whatever they can instead of losing full premium on that strike. Another way to mitigate this is by using strategies like Bull Call Spread and Bear Put Spread which reduces the burden of premiums.
3. Amplified losses in selling options: Options sellers enjoy the shrinking premiums due to time decay. But with the increase in volatility and wild swings, their losses can be far higher. Thus, it is always advisable that a trader deploy options strategies by placing proper hedges that limits the risk. Strategies like Bull Call Spread and Bear Put Spread help traders earn premiums while limiting the risk.
4. High margin requirements: Although option selling seems lucrative, it requires margin. The margins are kept reasonably high to protect small investors with limited capital and knowledge from entering trades they do not fully understand. Experienced traders with higher capital use hedging strategies to avoid the brunt of hefty margins. With the appropriate hedges in place, the traders also cap the downside exposure if the trade reverses.
Are you keeping these challenges in check while placing your next trade? To further boost your trading experience, Upstox will soon launch its options strategy builder for all its platforms. Through the strategy builder, you will have a disciplined approach, better downside protection, automated P & L calculations, and above all, a hassle-free multi-leg order placement in just 3 clicks. So, stay tuned.
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