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So, today we’re going to talk about a very interesting topic, that is, 7 reasons why traders love options. So, when we start trading in the stock market, we have no idea what futures and what options are. Most of us start with the cash segment because up until now, that’s the only thing that we have heard; buy and sell shares.

That’s what we have been told by our friends or family, TV, newspaper, or any other blogs, etc. As we start getting deeper into trading, we also start to understand that there are other instruments such as futures and options. When traders start to take an option, they don’t want to go back to the cash segment. Why?

Well, it’s almost like, let’s say you were drinking tea and then you tasted a dessert and after tasting that dessert if you go back and take a sip of your tea, how would you feel? Do you get the same taste? No. However good that tea might be, you won’t get that taste because now you have experienced a new level of a sugar rush.

That is exactly why options are considered the most exotic trading instrument around the world and especially in India.

This chart right here shows us that turnover in options means how much trading is happening in options over the years. As you can see that the popularity of options has grown exponentially over the years. But why is there so much interest in options? Why are traders so fascinated with options? Well, in this session, I will give you 7 reasons why and so let’s get started.

7 REASONS WHY TRADERS LOVE OPTIONS

Reason 1: Options Make Crazy Moves

So, the reason number 1, traders love options so much is that options make crazy moves. The first thing that fascinates almost everyone about options is that how quickly option prices go up and down within the same trading session. Let’s take a look at this particular option. So, this 50-rupee option went up to 250 rupees and then came back down again to 50 rupees in the same trading session.

They went up 5 times and then came back down to the same level and these kinds of moves are not abnormal. They happen all the time. Now you compare these kinds of moves with any other stock or any other cryptocurrency or any other instrument out there. Can you imagine anything else making these kinds of crazy moves?

I mean true once in a while, you can have stocks like Adani Enterprises, which can go down, let’s say 25, 30%, but that will happen only once in a while. With options, however, the party is always on. These kinds of moves are very, very common and the fun part here is that for the options to make these kinds of moves, the underlying of that option need not make that kind of a move. So, if we take the example of the same option that we looked at, for this option to go up 5 times, how much percentage do you think nifty had to move? Let’s take a look right here. We can see that nifty moved less than 2%…

A less than 2% move in nifty induced 5 times move in the option, which was based out on Nifty’s price. So, the most fascinating thing about options is that they make crazy moves and this is exactly what attracts a lot of traders because they start imagining in their head that, oh, look, if I would have traded with 1 lakh rupees on this particular option, that one that could be, would have become 5 lakh rupees.

So that kind of extrapolation starts happening in our head and that is exactly why traders are so much attracted towards options.

Reason 2: Options can be traded with Very Low Capital

Now let’s talk about reason number 2, which is that options can be traded with very low capital. Most of the traders in the Indian stock market come with a capital of  2 to 5 lakh rupees.

With that kind of capital, they are looking for a trade where they can make some serious money. However, the problem with low capital has always been that you can be a very good trader and you can make 10% or 15% per month on your capital. But if your capital itself is low, how much money are you making?

10% up to 2 lakh is still 20,000 rupees and that’s not a lot in a month and that is exactly why traders with low capital are always on the lookout to get around this limitation of having low capital. Up until now, the cash segment was their favourite for a very long time because the brokers used to provide a lot of leverage i.e. 40, 50, or even 60 times.

So, with 1 lakh rupees, you could potentially trade with 50 or even 60 lakh rupees worth of trades. However, with the new SEBI regulations, all that leverage is gone. Now the maximum leverage that the brokers are allowed to offer on an intraday basis is about 5 to 6 times. The same is also applicable for the futures market as well.

So, with Rs.1 lakh of capital and the subsequent leverage, people used to trade lots of nifty, but now with Rs.1 lakh, you cannot buy even 1 lot of nifty. Due to these regulatory changes, traders are now gravitating towards buying options because in options, you’re not taking any leverage and you’re paying upfront.

So, what is SEBI taking away from you? Nothing. You can trade with any capital that you want. For example, this particular option right here, I can buy this option for as low as 500 rupees. No problem. So even with a small capital, I can start trading in options and when you combine this reason with reason number 1, that options make a crazy move induces hope in a lot of traders that, even with a small capital, they can make some serious money. That is exactly why option buying has become the last resort of all the traders with relatively low capital.

Reason 3: Options Have Something for Everyone

Now, the reason number 3, why traders love options so much is because options have something for everyone.

So, options are like a one-stop shop for every trader. For example, if you have low capital, you are welcome. You can trade with Rs.5,000 ,Rs.10,000 or Rs.20,000 rupees. If you have big capital, you’re also welcome to sell options for Rs.1 cr, Rs.2 cr, Rs.3 cr and there is no limit. If you’re a risk-taker, you can also take naked options.

If you are risk-averse, you can trade with an appropriate hedge. If you’re a working professional, you can trade in the monthly options. If you are an intraday trader, you can trade in the weekly options and if you are the one who is looking to hit a jackpot, options are the instrument of choice for that.

The point I’m trying to make here is that options are such versatile instruments that they can be configured in any number of ways to suit the requirements of almost every kind of a trader.

Now, as far as I’m concerned, I trade options routinely; sometimes on a swing trading basis, sometimes on a positional basis and sometimes on an intraday basis. Most of the time I sell options, sometimes I buy options, but whatever I do, I do it with caution and I do it with a clearly defined risk. So, here are some of the trades that I took this week.

Just to give you guys an idea. So, guys, my only advice here is that it takes time to find the right style for you in options. Don’t be in a hurry as it will require a few trials and errors, but I’m sure you’re going to find your style.

Reason 4: Strategies for Every Type of Market

The reason number 4, because of which I got gravitated towards options is that through options, you can build strategies for every type of market.

So, guys, everybody makes money in the bull market. I remember back in 2009 when you buy any stock that stock would most likely go up 5% or 10% in the next 2, 3 weeks. The same thing happened in 2016, 2017; and the same thing is happening right now as we speak. So, when the markets are trending, it makes us believe that we are smart.

So, we like to show up and tell our friends that look, I’ve spotted this stock, and now that stock is up 10% or 15%. Look how smart I am and how good of a trader I am. I, myself, am guilty of doing that. What I realized was that the real metal of a trader is tested when the markets are not strongly trending.

So, what happened after 2009. For 3 years, 2011, 2012 and 2013, the market stayed in the range. and did nothing. All those big short traders whose only strategy was to just buy the stock and hold them for 2 to 3 weeks, got in trouble.

Now the same thing happened after the bull run of 2016 and 2017. So, for 3 years, 2018, 2019, 2020, the market did nothing. Professional traders understand that it’s easy to make money in a bullish market, but what is more important is to be able to make money in every market context,i.e. bull market, bear market, sideways market, range market, bond. Market, highly volatile market and low volatile market.

Can you do that in the cash segment? No. Can you do that in the future segment? No. The one and the only instrument that has the capability of generating strategies for every type of market is options and that is why I believe that options are such an elegant, sophisticated instrument.

Reason 5: Options Are Perfect for Hedging

Now the reason number 5 traders love options so much is because options are perfect instruments for hedging. Let us forget about making money for a minute and let us talk about protecting our portfolios, investments and even our trades. What happens when a big market crash, like the one that we saw in 2020 comes and how can you protect our portfolio?

How can we protect our positions from getting wiped out? Can that be done in the cash segment? No. Can that be done in the future segment? Technically, yes, you can do it, but the practical problem there is that futures are expensive and they require much more capital. Hence options are considered the most efficient way of hedging your portfolios or hedging your positions.

There is always a way in option to find a hedge, which will suit your capital and risk appetite.

Reason 6: High Probability Trades

Now, moving on to reason number 6. Through options, you can take high probability trades. Let us think about it for a second. How do you make money in the cash segment or the future segment, when the stock or the future will go up or go down?

Let us say, for example, you bought shares of Tata steel. The only way you’re going to make money in Tata steel is that if the share prices of Tata steel will go up else, you will lose money. So, the odds of making money on any trade, statistically speaking is 50%, but in options, you can create strategies with all kinds of probabilities at 50%, 60%, 70% and even 80 or 90%.

All you have to do is find the perfect balance between risk-reward and probabilities. For example, you have a bullish view of the market and you are expecting Nifty to go up. Now, let me show you the same view on how to create multiple strategies with different probabilities of success. So, this is one strategy right here where I’ve just basically bought a call option, but the probability of success is only 31%. I’m not very happy with it and want the probability to go higher. What I can do now is that, instead of buying a call option, why not I sell a put option?

Now you can see that immediately the probability of success has gone from 30% to 65%, but of course, the probability also comes with a risk reward. In this case, your reward is only 7,000 rupees, whereas the risk is almost 11 lakh rupees, not acceptable. So, what can we do about it?

Well, how about we try with bull call spread? With the bull call spread, the risk-reward became a little bit better, much more reasonable, but the probability of success again has gone down. Assume that you want to increase the probability. You are not so much concerned about the risk-reward, as long as it is not too bad.

So, let us try this bull put spread. Now things look much more reasonable to me. The risk, first of all, has gone down significantly from that level of 11 Lakh rupees and it has come down to only 17,000 rupees and the probability of success is 61%. So, this is a perfect example of how options are. By playing with the risk-reward and probability, we can find that it suits our risk profile.

Reason 7: Risk Defined Strategies

Speaking of risk reason number 7, why I love options so much is, because, through options, we can create risk defined strategies. Now, what exactly does this mean? So, let’s go back to the same example that we were seeing earlier, right.

In this example, the maximum loss is 17,000 rupees, but is it the maximum loss? What happens tomorrow if there is a new crisis that hits the market? Everything goes back down to 7,000 or 8,000 nifty levels. In that case, will I still be incurring only a 17,000 repeats loss? Well, let’s simulate.

So, this is the Nifty target right here. I’m just going to keep moving this Nifty target down. Nifty is currently at 15,000 and I’m projected to lose 15,000 rupees. Let me keep going down and down. Nifty has now come down to 14,000 and what is my projected loss? 17,000 rupees. What if I make nifty to 10,000?

Nifty falls 36%. How much am I going to lose, 17,000 rupees? How about I make Nifty 1000? How much will I lose? I will still lose only 17,000 rupees. You might now understand how powerful these strategies are. Once you have defined the maximum loss, you will never, ever incur a loss.

The best feature of options is that you can define the strategies and you can go back to your working and do whatever you want to do in your life. You will never have to worry that you will incur losses more than the maximum loss that you have already defined. So, guys, by now I’ve given you all 7 good reasons why options are such a wonderful instrument to take, but I will not be doing my job if I did not caution you about the dangers of trading in options.

Dangers of Trading in Options

Every time I think about options, I am reminded of a poem by a very famous Hindi poet, Ramdhari Singh Dinkar, who wrote these beautiful lines reminding mankind about the dangers of playing with science and technology. Here Dinkar Ji is cautioning us that even though science is wonderful, but playing with science is like a kid playing with a sharp sword.

If you don’t know how to handle it, it can cut you and can finish you. The same thing goes with options. Options are exciting, exotic and very sophisticated instruments. When used wisely,  options can help you make a lot of money, but options are also dangerous. So, if you don’t know how to trade in options, you don’t have an understanding of how options work in real life.

If we don’t understand how options behave and what are the risks that you are exposed to when you’re trading in options, then you can also incur some significant losses. With that caution I’m going to end this session.

I hope that you learned something new today.