Saturday 30 January 2016

TRADING WITH ADDITIONAL RISK

It concerns risk taking, and although the statement may seem to be trivial, it is far from it. It is an important concept. 
Don’t expect to make more money for taking risk; just know you have to take additional risk to make more money.
If you don’t understand the difference, you should not be taking risk.

One of the basic concepts regarding investing is that there are no free lunches and that you, the investor, must take some risk in order to earn a return on your investment.
If you are a very skilled trader, you may be able to get away with taking very little risk. However, for the vast majority of investors/traders, we must take on additional risk when we seek to earn a higher profit.
I hope that makes sense. If you were able to earn a high reward on your investments with very low risk, then almost every investor on the planet would go after those rewards.
Usually, no further discussion is required because we all understand when many people go after the same investment product, then there are often those who are willing to accept a slightly lower reward. That in turn drives down the overall reward available to investors. To understand why this is true, just imagine a $100 bond that returned $10 every year. You love that 10% annual return. But another investor may we willing to accept less and may bid $105 for that bond. When that happens, you can no longer buy the bond for $100. The price is now higher and the reward is now less. The process continues (i.e., the cost of the bond increases) until equilibrium is reached and no one is willing to pay a higher price.
By the time that happens, the bond could easily be selling for $120 and the annual return would be 8.33%.
THE MAJOR POINT IS THAT EXTRA RISK DOES NOT GUARANTEE ANY EXTRA REWARD. IN FACT THERE MAY BE NO REWARD. I
magine a careless, inexperienced trader adding risk to his/her portfolio with the expectation that it will lead to greater gains.
Using the above bond example, the fact that the business had to pay as much as 10% to sell the bonds initially suggests that the company may never be able to repay the debt. Financially sound companies do not have to pay so far about current market rates when selling bonds. The fact that this company has to pay so much in order to attract lenders says a lot about the high risk involved when lending money to them. It's great to earn $10/year per $100 investment, but if the company defaults and you never get back any of the $100 invested, that is an example of no reward.

Friday 29 January 2016

OPTIONS ARE NOT STOCKS...!!!!!

"SELL TATAMOTORS FUTURE BELOW 336 TGT 334.5/332.2 SL 338.9" 
"BUY NIFTY 7500 CALL@ 154 TGT 179/194 SL 128"
Whether you are a trader or an investor, your objective is to make money. And your secondary objective is to do so with the minimum acceptable level of risk.
One of the major difficulties for new option traders arises because they do not really understanding how to use options to accomplish their financial goals. Sure, they all know that buying something now and selling it later at a higher price is the path to profits.
But that is not good enough for option traders because option prices do not always behave as expected. 
For example, experienced stock traders do not always buy stock. Sometimes they know sell short hoping to profit when the stock price declines. Too many novice option traders do not consider the concept of selling options (hedged to limit risk), rather than buying them.
Options are very special investment tools and there is far more a trader can do than simply buy and sell individual options. Options have characteristics that are not available elsewhere in the investment universe. For example, there is a set of mathematical tools ("the Greeks") that traders use to measure risk. If you don't grasp just how important that is, think about this:
If you can measure risk (i.e. maximum gain or loss) for a given position, then you can manage risk. Translation: Traders can avoid nasty surprises by knowing how much money can be lost when the worst-case scenario occurs.
Similarly, traders must know the potential reward for any position in order to determine whether seeking that potential reward is worth the risk required.  
For example, a few factors that option traders use to gauge risk/reward potential:
·         Holding a position for a specific period of time. Unlike stock, all options lose value as time passes. The Greek letter "Theta" is used to describe how the passage of one day affects the value of an option.
·         Delta measures how a price change -- either higher or lower -- for underlying stock or index affects the price of an option.
·         Continued price change. As a stock continues to move in one direction, the rate at which profits or losses accumulates changes. That is another way of saying that the option Delta is not constant, but changes. The Greek, Gamma describes the rate at which Delta changes.
This is very different for stock (no matter the stock price, the value of one share of stock always changes by $1 when the stock price changes by $1) and the concept is something with which a new option trader must be comfortable.  
·         A changing volatility environment. When trading stock, a more volatile market translates into larger daily price changes for stocks. In the options world, changing volatility plays a large role in the pricing of the options. Vega measure how much the price of an option changes when estimated volatility changes.

Thursday 28 January 2016

WRITING COVERED CALLS

I prefer to begin discussions about learning various option strategies with Writing Covered Calls because it is easy to understand and because it will feel natural to stock market investors.
First, a definition: A covered call is a position consisting of two parts:
·         Long (that means you own) 100 shares of stock.
·         Short (i.e., you sold) one call option whose underlying asset is that same stock. 
WHY BEGIN WITH THIS STRATEGY?
Although it is not true for every new option trader, most people who come to the options world have some prior trading experience -- specifically, buying and selling stock. Writing covered calls is an extension of that investment strategy. I recommend beginning an options education with this strategy for one basic reason: It is a natural extension of something that most new option traders are already familiar with (buying stock).
That makes it much easier to glide into using options.
This is not the appropriate space to talk about whether an individual investor is better off choosing individual stocks or sticking with index funds or specific exchange-traded funds (ETFs).  I have a deep dislike for traditional mutual funds because of their steep sales charges (loads and/or redemption fees) and excessive management fees. If you are someone who already invests in individual stocks, then the strategy described below is likely to be very useful during the early stages of your options-trading career.
STRATEGY DESCRIPTION
Covered call writing (CCW) is a method for reducing risk associated with owning stock. Stockholders may earn a very large profit when the stock price soars, but they are subject to large losses when the stock price tumbles.
If you prefer to hedge that downside risk, then selling (writing) one call option for each 100 shares of stock owned is an efficient hedging method. 
WHY IS A COVERED CALL A HEDGED POSITION? 
As a reminder, when you sell a call option, the buyer is granted the right to buy your stock (at the strike price) at any time before the option expires.
Therefore, if the stock is trading above that strike price when expiration arrives, the call owner will exercise her rights to buy the shares, and you are obligated to sell. Profits are limited because you cannot sell your stock at any price higher than the strike price as long as you remain short that call option. In other words, you sacrificed the possibility of selling stock at a higher price in exchange for the cash premium that you were paid when selling the call.

Wednesday 27 January 2016

SUNK COST AND RISK MANAGEMENT

LOSING MONEY? WHAT NOW?
If you find yourself thinking along these lines [placing a wager that recovers lost money and gets you back to break-even status is so important, that taking extra risk is acceptable], then don’t worry, you are like the majority of people in the world today.
Just remember that though it can be very tempting to take a big risk in order to break even, that risk might put you much further in the hole. Before you take that gamble, think very seriously about the consequences of losing.

If you can consider it rationally, you will realize that it’s much better to stop before you do further damage. Sometimes it’s better to accept a loss and walk away—much like sunk money.
It is very difficult for most people to walk away from a situation in which money has been lost. The temptation to continue playing the game is so strong -- not only for financial reasons -- but because it is psychologically unsatisfying to end the game as a loser. Getting back to break even is almost addictive.
In different language: Consider this scenario: You play poker, bet at the racetrack or invest in the stock market, and find yourself losing $100. You can walk away or continue to play. For most people, the possibility of recovering that $100 is so tempting that they may wind up losing far more money than they can afford to lose -- just in an attempt to recover losses.
This is the important part that is difficult for rational people to recognize: When people make an investment, earning $100 has a certain amount of pleasure associated with it. However, if they first lose $100, then earning $100 is far more satisfying -- despite the fact that it has the same financial value. "Not losing" is more satisfying than "winning" -- and that may lead to taking more risk than is prudent.
SUNK COST
When money has been lost and cannot be recovered, there is nothing that can be done. That is the sunk cost.

Monday 25 January 2016

THE APPEAL OF BINARY OPTIONS

There is a type of option that is not offered by the "regular" options exchanges (such as CBOE or ISE). It's the binary option. 
Binary options are very easy to understand. The gambler (sure, there is an effort to describe players as stock-market investors, but trading binary options is gambling) places a bet. It works like this: Some future event will either be true or not true -- and you can take either side of that bet.
Another way to state the gambling proposition: Your wager will be worth $100 or $0 when the option expires. There are no other choices. If the event comes true, those who bet on "come true" can cash in their wager for $100. Those who bet it would not come true lost, and their "investment." is worth $0 (i.e., it expires worthless).
For example: "The S&P 500 Index will be up more than 6.00 points today." In the morning, before the market opens, let's assume that the futures markets are neutral. In that scenario, it is more likely than not that the proposition will turn out to be false because the index rises by more than 6 points less than half the time, or "not true" when the day ends. Thus, people who want to wager that the proposition will come true will get a little bit better than even money odds. Those who bet it will not be true must accept odds of less than even money (i.e., they can win less than $1 for each $1 wagered).
Binary options can also be used for longer-term situations, such as:
  • Donald Trump will be elected President of the USA in 2016
  • The stock market will close lower on Dec 31, 2016 that it did on Dec 31, 2015
  • Hillary Clinton will be elected president of the USA in 2016.
  • The Chicago Cubs will play in the World Series in 2016.
It's very easy to understand how binary options work. Most people like to predict things. When you have a strong hunch, it is tempting to place friendly bets with friends.