OPTION TRADING TIPS

Wednesday, 1 April 2020

TIME DECAY IN OPTION

The ratio of the change in an option's price to the decrease in time to expiration. Since options are wasting assets, their value declines over time. As an option approaches its expiry date without being in the money, its time value declines because the probability of that option being profitable is reduced. Time decay is a crucial component traders consider when deciding when/where to buy sell options.

5 SMART WAYS TO MAKE MONEY IN VOLATILE STOCK MARKET

There are numerous reasons for volatility in the stock market like now a days coronavirus is ruling the market, and it should be accepted as the underlying reality of investing.Timing the market is not easy and if you are not confident about taking advantage of volatility, you should avoid it.

As an asset class, stocks are volatile by nature. There are numerous reasons for volatility in the stock market and it should be accepted as the underlying reality of investing. Unless there is a market-wide consensus of the future, a trend cannot be in place and until a trend is in place, markets will always be volatile. Every trader/investor should be equipped with strategies to make profits in such uncertain scenarios. Here are the top five ways to make money in a volatile market:

1. Options Strategies – There are several ways of making money in volatile scenarios using options strategies. Some popular strategies include short straddles, short strangles, iron condor, covered call etc. Any strategy which involves selling either at the money or Out of The Money (OTM) or At The Money (ATM) options with an expectation that the market direction will not change much and the options premiums will decay significantly or expire worthlessly, thereby generating profits for the writer. Selling options in volatile scenarios can be very tempting but it is extremely important to be hedged, otherwise, the downside could be higher if you are wrong. 4 legged options strategies such as Iron Condor and Iron butterfly give you the perfect hedge. It is a good strategy to enter these strategies across different stocks with low correlation so that you have a higher probability of success. A covered call is a very effective and yet simple strategy that works very well. In fact, it is designed to make the maximum amount of money in moderately volatile markets where the price of the underlying is within a tight range and the options premiums are high. Executing covered call strategy successfully over a period of time helps generate extra returns on a stock.

2. Have a long & short exposure – When there is no clear direction and when the market can go either way, it is not always sensible to have a 100% long-only portfolio. It is much wiser to have a percentage of your capital in short trades. The ideal case would be if you are long strong/bullish stocks and short weak/bearish stocks during the volatile phase. When going short, choose the weakest stocks from the weakest sectors. Generally, despite having fallen a lot already, their downtrend will continue if the overall market sentiment is uncertain. This is a rule of thumb but must be exercised with caution as shorting requires a level of skills that can be skillfully executed by active traders only. While having a short exposure, it is extremely important to be aware of the range of stocks as entering trades at the wrong prices can completely disrupt the profit potential. The long/short ratio should depend on your outlook of the market. For instance, if you are moderately bullish, then the long/short ratio should be in the range of 65:35 or so. A balanced approach such as this will help play market fluctuations more effectively. If you are not savvy with these concepts, it is best to withdraw a certain portion of your long portfolio and park in a less correlated asset class such as gold or fixed income.

3. Rupee Cost Averaging – Contrary to popular wisdom, averaging your positions can be very beneficial during volatile markets. Averaging is good, but averaging with leverage is a sin. Leverage changes the equation dramatically because the margin of error reduces substantially and also the waiting power is extremely limited. Hence, the odds are stacked against a trader who averages against the trend with leverage. That aside, if you can buy equity every time the market corrects within a range, then you will accomplish lower buy averages and that’s a good thing for your portfolio.

There are two ways of doing this; you can either sell your existing holdings at the highs and re-purchase them at lower prices and play the range or you can infuse additional capital which can help improve the average purchase prices. If you can do this successfully, you will be operating within a margin of safety as long as the markets are within a range. A classic example is SIP investments during volatile markets is a great strategy.