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Nifty has surged in 2021 , about 100% from the swing low of
2020. The Indian market in last one year has also witnessed a huge number
of additions in trading accounts due to more time available with people working
from home to allocate to trading. Most of these traders are newbies and often
come with small capital to be deployed.
Any
options trade of less than Rs 2,00,000 is termed as small
capital. And since small capital can deploy low capital strategies, we
will consider only buying options which could be both calls and puts.
Options
trading, unlike futures or cash market trading, has a lot of complexities and
hence I’ll list down few quick fixes to know for a guided start.
Position
Sizing
Let us
start with how much capital you should deploy. Generally, newbies make a
mistake of treating options like stocks. Options are wasting assets and
have a very small shelf life mostly a month for Indian markets as expiries
beyond that aren’t liquid.
This
means that deploying full capital would mean blowing up complete capital in
just a few months and sadly this is the fact where within 6 months most of the
traders blow up their accounts. So, it is important to know how much capital to
deploy in each trade.
To
understand the concept of why we need position sizing, consider this example.
Let’s say we are flipping coins to predict the outcome of head or tail, we know
with enough number of iterations eventually it will be 50:50, but what if you
predict Tails and Head pops-up 5 consecutive times? Will you have enough
capital to sustain that bet? This is exactly where position sizing helps.
For
small accounts, I recommend a per trade allocation of 5% with an overall
allocation of 10% at any given point of time. That means with a capital of Rs
2,00,000 one should allocate no more than Rs 10,000 each trade and two parallel
trades can be opened at a time. This will help you sustain consecutive losses.
Setting
the Holding Period
Trading
single options should have a defined maximum holding period. A common mistake
new entrants make is holding the trade for too long which deteriorates the
probability of making money due to theta decay outrunning the probability of
profit. Single Option trades should be extremely short term so participating in
breakout / breakdown zones and quickly moving out of the trade should be the
intention.
If you
want to carry trades, then the maximum holding period should be 3 days but in
expiry week this should come down to intraday. So, one needs to follow the time
stop loss and exit without relying on hope.
Pre-calculate
Stops & Targets
Forecasting
studies are generally conducted using the underlying instruments and its
extremely important to align your option trades to those targets and stops.
Using
an Option Calculator which is generally available online, can help converting
your underlying stops and targets to option stops and targets. Pre-calculate
the option level using underlying forecast levels and time. This will help your
trades avoid whipsaws due to inaccurate calculations.
Avoid
stocks in news
Often
new investors jump in heard trading i.e. stocks which are hot in news.
Generally, as market has a unique way of predicting the impact of news, what
might sound positive news may have been accounted for in the price or market
may have a different prediction methodology trapping the price on a reverse
direction. Stock valuations doesn’t matter much to options trading as the time
scale for these trades are extremely short term and things are more led by demand
and supply in short term.
Avoid
unknown events
Another
general mistake is to trade events where outcomes are un-known, that is very
close to gambling. Remember most of the people lose in a casino as they enter
with an intention to gamble and have fun.
If you
treat your trading like a business, you will never want to enter a trade which
leads to a gamble. So, avoiding event days like Monetary policies, upcoming
stock results, fiscal policies, etc. is generally a good idea. In these events,
even if your predictions are right still you may lose to volatility.
Limit
number of open trades
Managing multiple trades simultaneously is a difficult task, so before adding a trade always ask yourself is there an open trade which can be replaced? If yes, choose to replace than to increase the overall bet. I recommend not to hold more than 2-3 open trades at any given time.
