Options trading can be tricky. Getting the view right, selecting the correct strike price, deciding the entry and exit points are just some of the considerations while trading options. Add to this the complications of getting stuck in an illiquid stock. It can get very frustrating for a trader. More so if you want to trade in options strategies.
This blog will help you learn about some of the common pitfalls that traders fall into while placing trades in options and more importantly, how to overcome those pitfalls. So read on.
1. Check liquidity: There are 203 scrips available for FnO trading at the moment. But not all of them have the same liquidity and depth. The traders must stick to the stocks that have high liquidity in order to avoid getting stuck in a trade, or worse, having to square it off or close the trade forcefully at a loss.
2. Check bid-ask spread: Traders must always check the bid-ask spread before executing a trade. Some strike prices or illiquid scrips have big gaps between the bid and offer price. Sometimes traders look at the “LTP (Last Traded Price)” and enter the trade without checking the bid-offer prices. This leads to unexecuted orders and chasing the prices.
3. Avoid deep ATM/OTM options: The lure of buying options cheap often leads to traders looking at far out-of-the-money options. This can lead to disappointment and even losses as the underlying stock must move a lot for the options to generate big profits. Similarly, deep-in-the-money options might cause trouble as lack of liquidity might not allow traders to exit at the correct market price. However, trading in liquid in-the-money and out-of-the-money options makes sense for traders deploying options strategies.
4. Look for best bid and offer order: Market orders are not allowed in options trading. And for a good reason. But that should not keep a trader away from entering or exiting a trade quickly. A smart route to do this is to place an order at the best bid or best offer price rather than “Last Traded Price”.
5. Utilise margin benefit through hedging: As options traders, we all know the sizeable margin we need to sell options. However, if you hedge your selling position by buying an option, not only will it help you limit your losses-instead it also gives you the benefit of reduced margin. The money you save by deploying a hedge can later be utilised in another trade to maximise your profit.
6. Trade with a stop loss: As a practice, no options trade must be placed without stop losses. And, this is not a number to keep in mind but an order to place in the system. Given the instrument's volatility, it might sometimes be difficult to exit a position at your stop loss price unless the order is placed in the system early on.
7. Trail your stop loss: For traders who wish to make big profits, trailing stop losses act as a huge advantage. It allows you to ride your profits and make big returns when a trending trade runs in your favour. Rather than exiting a trade with a small profit, trailing stop losses help you ride the wave.