Share Market

Options are one of the derivative instruments in the financial world which provide the investor with the right but not the obligation to execute the contract with specification of price and validity period.

Although profitable, options as an instrument can prove to be extremely complex and risky.

While strategies involved in options trading can make them less risky, the fact always remains that the options (especially derivative instruments) involve more risk than equity instruments.

Risks involved in options trading include…

Greed for money: Speculative income (the form of income derived from options) is one of the major reasons in options trading. One has to stay connected to the options world to get the continuous update of their money and protect them from getting the loss with the blink of the eye.

Capital Loss: Since options involve the use of a derivative instrument, the loss faced in percentage as compared to that of trading in equity is ten times greater.

Margin trading: The risk involved in options trading is significantly high. Considering the risk involved, if one involves in margin trading, one can fall in significant debt with the broker if the trade bombs (This happens more than often)

Strategies to save yourself from the risks…

While option trading can make life risky, there are steps which can be taken to reduce the risks and benefit from trading in the financial instrument. Following are the few steps which one can adopt to mitigate the risks involved in options trading:

Stick to your strategies: An old adage says – experience is the best teacher. When you know the risk involved in the instrument, it is always better to have long trading expertise and a standard plan to help detect and avoid the dangers involved in option trading. Wise men in the market always say, “Stick to your plan! “

In time technical analysis: It is learnt that the rules for technical analysis for an option are very different from those of a share or equity. Once learnt, technical analysis in options trading helps in proper timing of the trade, which can indirectly help in mitigating the risks involved in option trading.

Asset/Capital Allocation: Since options are a risky financial instrument, experts are known to have recommended only 2% of the capital to the option trading. Also, reports have known to suggest that one must keep at least 20% of the capital to invest in “buy“ oneself out of the bad trade before it becomes a huge margin responsibility to pay off.

While option trading provides a quick source of income for short term traders, the risks involved in trading the financial instrument causes them to be on the toes and continuously vigilant about their trades. However, to be on the safer side and maintain your stable heartbeats while trading in options, one must ensure that he or she knows various option trading strategies, apply correct technical analysis and be sure not to let greed overtake investment strategies.