Golden Rule For New Traders In Option Call Put Trading !!!

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Any options trade of less than 2,00,000 rupees is called small capital. And since low capital can be used to implement low capital strategies, we will only consider buying options, which can be both calls and puts. Options trading, unlike futures or cash market trading, is very complex and we are therefore listing some quick fixes that you should know for a guided start.

POSITION SIZING

Let's start with how much capital you should invest. Generally, newbie traders make the mistake of treating options like stocks. Options are asset-wasting and have a very short shelf life, typically a month in Indian markets, as expiration periods beyond that are illiquid. This means that deploying all of the capital would mean blowing up all of the capital in just a few months and unfortunately this is the case when most traders blow up their accounts within 6 months. Therefore, it is important to know how much capital to put in each trade.

Consider this example to understand why we need position sizing. Suppose we toss coins to predict the outcome of heads or tails. We know that given enough iterations it will ultimately be 50/50, but what if you predict tails and heads come up 5 times in a row? Do you have enough capital to sustain this bet? This is where position sizing helps.

For small accounts I recommend an allocation per trade of 5% with a total allocation of 10% at any point. This means that with a capital of 2,00,000 rupees one should not allocate more than 10,000 rupees per trade and two parallel trades can be opened at the same time. This will help you absorb consecutive losses.

SPECIFYING THE HOLDING PERIOD

Trading individual options should have a defined maximum holding period. A common mistake newcomers make is holding the trade for too long, which worsens the probability of making money as theta decay outweighs the probability of winning. Single option trades should be extremely short-term, so participating in breakout/collapse zones and exiting the trade quickly should be the intent. If you want to conduct trades, the maximum holding period should be 3 days, but in expiration week it should be up to intraday. So one must follow the time, stop the loss and get out without relying on hope.

CALCULATE STOPSLOSS AND TARGET IN ADVANCE.

Prognostic studies are generally conducted using the underlying instruments. It is extremely important to align your option trades with these targets and stops. Using an options calculator, which is widely available online, can help convert your underlying stops and targets into options stops and targets. Pre-calculate option levels based on underlying forecast levels and time. This helps your trades avoid whiplashes due to inaccurate calculations.

AVOID STOCKS IN THE NEWS.

New investors often jump into the trade, i.e. in stocks that are breaking the news. Because the market has a unique ability to predict the impact of news, positive sounding news may have been factored into the price, or the market may have some other prediction method that pushes the price in the opposite direction. Stock valuations don't play a huge role in options trading because the timescales for these trades are extremely short term and things are driven by demand and supply on the shorter term.

AVOID UNKNOWN EVENTS.

Another common mistake is trading events whose outcome is unknown, which is very close to gambling. Remember that most people lose at a casino when they enter with the intention of playing and having fun. If you treat your trade like a business, you will never want to enter into a trade that results in a gamble. Therefore, it is generally a good idea to avoid event days such as monetary policy, upcoming stock results, fiscal policy, etc. In such cases, volatility can make you lose even if your predictions are correct.

LIMIT THE NUMBER OF OPEN TRADES.

Managing multiple trades at the same time is a difficult task. So before adding a trade, always ask yourself if there is an open trade that can be replaced. If so, opt for a replacement rather than a total bet increase. I recommend not holding more than 2-3 open trades at a time.