Top Options trade at the top

F&O Cues

Trading at the top is very ‘confident boosting’ for investors but for traders it becomes equally difficult because every new transaction comes with two fresh challenges.

1. Stop Losses and the immediate bottoms are farther with every rise.

2. Low confidence ideas are difficult to execute. (Not much room expected for further rise)

Options trading holds answers to both challenges and more. Let us look at one challenge at a time and get the solution in terms of Option Trade to conquer that fear and boost confidence.

1. Stop Loss too far

Well, ideally with Options we do not have situations of unlimited loss when we Buy options. So, no matter how far your stop loss is the maximum we can lose is the Option Premium. Second problem is the options bought will lose money with passage of time. We can deal with it by creating Vertical spreads.

What are Vertical Spreads?

For a bullish trade, instead of just Buying a Call with strike close to the current market price of the underlying, Buy that Call and at the same time Sell Higher Strike Call (2-3 steps away). Similarly, for bearish trades Buy a Put close to current market price and Sell Lower Strike Put (2-3 steps away).

Example:

Future @1,000

Bullish: Buy 1,000 Call & Sell 10,50 Call

Bearish: Buy 1,000 Put & Sell 950 Put

Premium profit in this trade will be miniscule compared to the actual move in the underlying stock or index. However, the margin required for such a trade is also very small. Hence, the overall return on investment is comparable to the move in the underlying stock or index.

What about Risk Vs Reward?

Generally, for smaller moves of around 5%, if the underlying target versus stop loss distance is 2 times, then the pay-off from the options trade with potential profit (in case of target) would be in the same range of twice the potential loss of premium (in case of stop loss).

The profits and losses are very small in absolute terms. So, we can take more trades. Also, if there are bigger moves, Option trade will lose less and gain more.

2. Low Confidence ideas.

For many trades where underlying has just gone up by 10-12%, we still want to Buy. In such low confidence trade, go further in terms of Buying and Selling Options.

Meaning, for bullish trade Buy 1-2 steps Higher Call and Sell 2-3 steps even Higher Call. For bearish trade, Buy 1-2 steps Lower Put and Sell 2-3 steps even Lower Put.

The premium outflow will be less. The profit will be lower but with high potential. Here, with such small premium outflow one can do away with stop loss and also wait till the end of expiry.

Farther strike creates lower premium expense. Hence, we can place this trade with no stop loss. Such is the way to handle the fear of missing out on Low Confidence Trades.

There you have it. Vertical Spreads, an easy answer to trade with confidence at the Top.