How to Trade in Options With Small Capital
Options trading can be an exciting and lucrative way to invest your money. However, it is also risky, especially if you have a small capital to work with.
Over the past few years, online trading has become popular in India. With the lockdown in 2020 prompting many individuals to try their hand at trading, there has been a surge of newcomers in the market. As most new traders typically have access only to small capital at first, any trade under Rs. 2,00,000 is deemed low capital in options trading.
It is elemental to employ strategies focusing solely on options that can be both puts and calls. However, commodity options trading may seem more challenging to comprehend. To help new traders navigate this, we have compiled a list of five essential points for how to trade in options in India.
Tips for options traders with limited capital
Here are some tips to help you trade in options with a small capital amount.
Understand position sizing
It is crucial to understand the concept of position sizing in options trading. New traders often make the mistake of confusing options with stocks. Since options have a limited lifespan, utilising all your capital would mean exhausting it in just a few months. That's why grasping the idea of position sizing is vital.
It enables you to determine the appropriate amount of capital to allocate to each trade rather than investing all your funds in a single trade and risking a significant loss. Remembering this options trading rule is critical.
Know when to stop
Establishing a maximum holding period for a single option trade is essential. Holding onto a business for an extended period can jeopardise your chances of profiting from it. The primary objective should be participating in breakout zones and quickly exiting the trade.
If you choose to carry the trades, the upper limit for the holding period should be three days, but during the expiry week, this time frame reduces to intraday trading. It is crucial to keep this options trading rule in mind to maximise your chances of success.
To ensure that your option trades are aligned with your stops and targets, it is essential to use forecasting tools and conduct research. You can leverage online “option calculators” to determine your option stops and targets in advance.
This approach can help you avoid losses caused by incorrect calculations and increase your chances of success in commodity options trading. By keeping this options trading rule in mind, you can improve your trading strategy and achieve your financial goals.
New traders may be tempted to follow the crowd and invest in trending stocks featured in the news. However, positive news reports may not always accurately indicate the options market. In options trading, conducting your own independent research and investigating the market before making any investment decisions is crucial.
Avoid falling for bandwagon trading and blindly following the crowd. By adhering to this critical options trading rule, you can make informed decisions and avoid unnecessary risks in your trading journey.
Avoid taking risks
When it comes to how to trade an option, one of the critical rules is to avoid taking risks when the outcome is uncertain or when the factors are unreliable.
It is important to treat options trading like a business and not gamble with unknown and volatile events such as fiscal or monetary policies. Despite making educated predictions, these events can lead to losses, therefore adversely affecting your trading portfolio.
Hence, avoiding unnecessary risks and making informed decisions based on reliable information and data is essential. By keeping this options trading rule in mind, you can minimise your losses and maximise your success in the long run.
Stick to a budget
Before you start trading, it is crucial to determine how much money you can afford to lose. This should be money you can comfortably part with without affecting your daily life. Stick to this budget and avoid investing more than you can afford.
It is a good idea to begin with small trades until you gain confidence and experience in options trading. Once you understand the market better and feel more confident, you can gradually increase your trade size. This will help you avoid significant losses if things are unplanned.
Trade liquid options
Focus on options that are frequently traded and have high volume. These options are more likely to have accurate pricing and are easier to buy and sell. You should also be aware of the bid-ask spread, the difference between the highest price a buyer is willing to pay for an option and the lowest price a seller is willing to accept. A narrow bid-ask spread indicates a prospect is more liquid and easier to trade.
Keep an eye on the expiration date.
Make sure you understand the expiration date of the options you're trading. Avoid options that expire too soon, which can be risky and unpredictable. Ideally, you should look for opportunities with a few months until expiration, as they give you more time to react to market movements.
Use stop-loss orders
Set stop-loss orders to limit your losses if the price of an option falls below a certain level. This will help you control your risk and prevent significant losses. A stop-loss order is an order to sell an opportunity at a specified price, triggered when the price falls below the set level.
Options trading is complex and requires knowledge and skills. Educating yourself on how to trade in options before diving into them is essential. You can read books, attend seminars, or take online courses to learn about options trading. Take the time to learn about the market, strategies and risks involved before making any trades.
If you are a novice on how to trade in options with a small capital, you should first dedicate time to research and educate yourself on the subject. This includes option writing, shorting and strategies for managing multiple open trades. With the amount of information online, you can quickly get up to speed on the basics of trading.It is essential to have a solid understanding of the markets you plan to trade in and the various financial instruments available before putting your money on the line. Doing so lets you know how to trade in options and make informed decisions that will help you achieve your trading goals.
Note: To help plan your trading activities and investment strategies, find here the NSE Holidays 2023, BSE Holidays 2023, MCX Holidays 2023, and Muhurat Trading 2023. Also see here to know more about the stock market timings.
The investment options and stocks mentioned here are not recommendations. Please go through your own due diligence and conduct thorough research before investing. Investment in the securities market is subject to market risks. Please read the Risk Disclosure documents carefully before investing. Past performance of instruments/securities does not indicate their future performance. Due to the price fluctuation risk and the market risk, there is no guarantee that your personal investment objectives will be achieved.