InvestorQ : What are the points to be kept in mind when selling options?
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Aashna Tripathi made post

What are the points to be kept in mind when selling options?

Answer
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2 years ago


There are some basic points you need to keep in mind when you sell options. Remember, selling options work best when you are hedged. For example, if you have a long position in a stock then selling call options is safer than just selling call options naked. Here is what you need to keep in mind when you sell options.

First and foremost, plan your margins and MTMs before getting into a position. Nothing can be sadder than having to sell your position in a fire-sale because you are not able to fund your margins. When you sell options the margining is like long and short futures. You need to pay the VAR margin, the exposure margin or the extreme loss margin and the MTM margins on a regular basis. VAR is a good starting point to plan your margins. Remember that you are also going to pay higher margins for volatility. In the past, only VAR margin had to be mandatorily collected by brokers. Now brokers have to collect VAR and ELM margins from clients in options.

Secondly, remember it is good to stay light ahead of key events. This is critical because key events not only trigger price movements but also volatility in the stock. Union Budget, credit policy, results of key companies, GDP / inflation data are all key trigger points, which can alter the course of select sectors. Watch out.

People quite often believe that fundamentals may not matter in options trading. That is wrong. In fact, spurts in options prices are led by fundamental shifts and news flows rather than by technicals or charts. Fundamentals are as important as cash market investing, if not more. If you are selling calls on SBI, understand why prices cannot move up. If you’re selling puts on M&M, understand why the stock price cannot go below a point. And of course don’t forget to look at historical price pivots of the stock.

Fourthly, time your options selling to the extent possible. If you’re selling calls on a weak stock, sell on a day of extreme strength in the market. If you are selling puts in a strong stock, sell on a day of extreme weakness in the market. Don’t sell your options too close to expiry. The risk may be low but then you don’t have much margin to earn. Time value always works against you when you sell too close to the expiry date. This way your risk-return trade-off is mostly favourable. And, don’t forget charts.

When you trade options, don’t try to outsmart the market. You can do that by buying options not by selling options. The risk return trade off works against you in that case. Trend is always your friend in selling options; and always will be. If a stock is showing consistent strength, don’t show bravado and sell calls. If you want to take contrarian bets on tops and bottoms, please do so by buying calls or puts. While selling options, be as close to the trend as possible.

Last, but not the least, when you sell options, remember that the devil lies in the detail. Keep your eyes open. You have sold calls and there is sudden OTM call accumulation! You find institutional buying in the counter. Liquidity is suddenly vanishing from the other side! These are all indicators that market knows a thing more than you. Just exit your position!