InvestorQ : As a trader in options, have a problem with timing my purchase and sale of options and so I lose money. Are there some basic rules on when to buy and when to sell options?
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As a trader in options, have a problem with timing my purchase and sale of options and so I lose money. Are there some basic rules on when to buy and when to sell options?

Answer
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Aditi Sharma answered.
7 months ago


An important decision that option traders need to take is when to buy or sell options. Remember, the leeway in option trading is very limited and hence you cannot afford to be very liberal in your approach. You need to focus on when to buy options and when to sell options based on your outlook. Here are a few pointers.

· If you expect the stock price to go up, you can buy a call option and if you expect the price to go down you can buy a put option. In both cases, risk is limited to the premium paid but profits can be unlimited when prices moves in your favour.

· An important point to remember is not to be enticed by deep ITM options just because they have low premiums. That is what they are worth and the chances of making money are very small.

· Let us also look at when to sell options. When you sell options your inflow is limited to the premium but losses can be unlimited. Unlike an options buyer who has an affirmative view on the stock, the seller of the options has a non-affirmative view on the stock. For example, a call option seller believes that prices will not go above a certain level and a put option seller believes that prices will not go below a certain level.

· Should you use options to trade or to hedge? Normally, the best use of options is for hedging and hybrid creation, not for trading or punting in the market. If you have bought an option, you can sell it in the market and book the profit or loss. Liquidity is not an issue in most of the index and stock options. However, to use options to just trade is to underutilize its potential.

· Remember that options should be ideally used for protecting against risk. If you have bought Tata Motors at Rs.182 in the cash market, you can protect by buying an Rs.180 put option at Rs.2. Your total cost goes to Rs.184 (182+2), but then your total risk is limited to just Rs.4 {182-180) + 2}. At no point will your loss cross this figure.

The crux of the argument is that options work best when used as a hedge or as a cost reducer. Trading in options as a proxy for stock market trading can look very enticing but it is fraught with risks.