3 ways of dealing with systemic risks of options trading

An Option trader deals with multiple systemic factors like Taxation, Exposure (Lot Size), Charges to trade, etc. The majority of these factors are uncontrollable and are more market-specific. Any changes here can alter the style of trading significantly.

Nonetheless, it has its purpose. Many times we have seen such tough calls taken by the Regulator, Government and the Exchanges for the greater good of the entire market. This may have altered the trading plans of many but for years I have been able to escape it with the help of these 3 easy ways.

1. Small Trades: This one has worked for me significantly. I know our traders’ instinct says when things are going your way bet big. I do not disagree with that either but the style of it can be modified at least.

The idea is to eat one bite at a time. No matter how big the appetite is or how high the confidence is in the trade, it makes sense to take it small. Frequent trades in small portions make more sense than one big trade and committing oneself to a sizable capital block.

Help: This helps with the recent transition where we expect a rise in lot size. This habit will never let one go overboard with the positions even if the lot size becomes bigger. At any initiation, we have the spare capital. So, in case such additional capacity is required due to a rise in lot size one does not run out of capacity.

2. Always Trade with Stop & Target: We do have a stop loss mechanism when it comes to futures but in Options, especially on the Buy side it never is the need of the hour. We do always have a limited loss trade on our hands. However, there will come a time when the underlying defies our analytical trading range (hits the stop loss in simple words). That is the time to get out.

There is also consideration of time in such trades. All of us know that a 100 Strike Call bought @5 with the stock trading at 100 will not yield a profit if we hold till expiry even after the stock goes up to 105.

The best way to deal with this is to use an Options Calculator and find what the premium will be if Stop-Loss or Target hits after 3-4 sessions. Those premium values become Target and Stop-Loss Premium.

Help: While the premium exposure will remain high in the trade, we will still have many trades executed with the same capital during the expiry as we are out of the trade as soon as it hits stop-loss.

3. Spreads: For all the trades that have a horizon beyond the 2-3 days, one can go with spreads. Instead of Buying just a Call/ Put add a Sell position in a higher Strike Call/ lower Strike Put and convert it into a spread. Yes, it will require some margin, but the time stop loss goes out of the equation.

Help: Huge Exposure suddenly becomes a small net premium paid as the risk to the capital. Target and Stop Loss calculations remain the same. This mitigates the risk to capital.