Options Unleashed: Discovering The Winning Strategy For Traders - Buying Vs Selling

Recently, SEBI released a report with deep insights. With a huge concern, they have shown that every 9 out of 10 derivative traders are losing their money in trading. Despite this, it is still such a fascinating business. Many traders are not aware of the right way of doing it, or the feasible approach and have over expectations in this trading business. In the blog we are going to Options Unleashed and its right approach and which strategies are best and how to select the best one for yourself. By the end of this article, you will be able to decide whether to buy or sell options. We are going to dive deep into the art of options trading, examining the merits and pitfalls of buying and selling options and uncovering the path to consistent profitability.

Options trading involves acquiring call or put options to profit from price movements. Call options give the right to buy the underlying asset at a set price, while put options grant the right to sell. Selling options allow investors to collect premiums and generate income if options expire worthless. Effective strategies are crucial for trading success. This guide presents buying and selling strategies, empowering traders to make informed decisions. From trend riding to short selling, learn techniques to enhance trading prowess and maximize profits. Consider market dynamics, risk appetite, and personal goals to discover the most effective strategies for success in options trading.

What is an Options Strategy?

In simple terms, an option trading strategy is when you have more than one leg of an option in your trading strategy. There are many proven strategies for bearish, bullish, neutral, or moderate views about the price's next movement Everyone has a different risk appetite and persona when it comes to option trading. There are two major components in options trading - theta and premium. An option buyer plays around with these.

If you think you are good enough at identifying directional moves, can predict the timing of fast movements, have fast execution skills, and can handle high-risk high-reward situations, then you should opt for single-leg option buying setups that provide entry and exit points. Options trading has an expiry date, so you need to be correct within the specified time to maximize your trades. Otherwise, if it goes against your trade direction or breaches the option expiry timeline, you may lose money. Timing the price is very hard. Even if your direction is correct, if it doesn't happen within the timeline, it won't make you money.

While using a single-leg trading setup, you need to always keep in mind that risk management is key. In this article, I am going to share one of my favourite single-option trading setups, but before that, we need to understand other types of trading strategies that are designed for safer traders or those who want to take calculated risks, those who want to make theta and premium work in their favour in case their view goes wrong. So, let's continue.

Now we have understood who and why we should use option trading strategies. Next, we are going to learn when to select a setup or an option strategy. Let's dive deep into it. If you think you can mindfully handle the options market's fast and furious nature and are ready to lose theta in case the movement slows down or the price moves sideways, then you can go for options signal leg trading. For example, if Nifty is currently trading at 19330 and you are bullish, you can buy a call option or sell a put option. It's worth noticing that option buying is different from option writing.

With the above two examples - if your view is bearish and you buy a 19400 PE at 122, the intrinsic value is only 70 but you are paying a premium of 52 for the probability (time) to prove your view correct. In case the price goes against you or closes at 19330 at expiry, you are going to lose the 52-point premium. If it closes at 19300, the intrinsic value of your strike will be the strike's value, which is 100. If Nifty closes at 19250, your strike premium value will be 150. Now, what if it goes against your direction and closes at or above 19400? In this case, your strike value will be zero, and you will bear a loss up to the extent of the premium you paid.

Option selling the other side of this coin. When you write an option with a bearish view, you will be liable to bear a loss up to the strike premium value at the time of expiry but profit will be limited to the premium you earned (gained at the time of shorting the strike price). Let's understand this with an example: Take Nifty (trading at 19330) from the above example. Your view is bearish, but you are not convinced about the time limit. You believe that the price may fall immediately or may take some time until expiry or so on.

Then you can short (write) Nifty 19400 CE at 62 (current price). Now let's understand when and how much you are going to earn. Here, you have written (shorted) the option and earned a premium of 62. So, in any case, you won't be making more than 62 points. If Nifty closes at or below 19400, you will make 62 points only. Your breakeven is at 19462, and if the price closes anywhere above this, it will result in a loss. Let's understand this with an example: if the price closes at 19500, your net loss is 38 points because you received only 62 points as a premium, but the 19400 CE value is trading at 100 (62 premium received + 38 premium paid).

Here are some famous and widely used yet effective setups for single-leg trading in options trading:

1. Trend Riding with Buying on Dip: In this strategy, you try to buy at support levels for bullish trades or sell at resistance levels for bearish trades. The risk percentage is smaller compared to the reward, but it has a higher stop-loss rate.
Pro Tip - Buying on dips up to 3 times has a higher win rate, but beyond that, trends tend to break. So, consider it up to 3 times to reduce the failure ratio.

2. Range Breakout Trading: Identify critical resistance levels and make strategic purchases when prices surpass those thresholds.

Pro Tip - If the breakout candle is too big, wait for retesting and trade after that. This way, you will be saved from fakeouts.

3. First 5-Minute Range: If the price gives a first 5-minute closing below or above the previous uptrend (flat opening case), it is a setup with a small stop-loss (range low of the day in the case of a long view and range high in the case of a bearish view). The target would be 1:3 or as per the price.

Pro Tip - Avoid the setup if the first 5-minute range is comparatively very big. This will reduce the high risk. Similar-sized candle ranges are most preferred for this setup.

4. EMA Golden & Death Cross with S&R: This is one of our favourite setups with Exponential Moving Average (EMA). It suggests that when the 50 EMA crosses over the 200 EMA, it's a bullish signal, and vice versa.

Pro Tip - Mark that level and trade it on a retest. This reduces the stop-loss rate in pullbacks.

5. Divergence of Trend at 20 EMA: Trade in the direction of the 200 EMA when divergence is retested for the very first time at the 20 EMA. It is one of the high-win-rate setups.

Pro Tip - It works best with 5, 15, 30-minute and 1-hour time frames.

6. Support and Resistance: Seize opportunities by buying near support levels, expecting price rebounds for potential gains.
Pro Tip - It's a reversal trading setup, so it's ideal to attempt a reversal trade only the first to third time of hitting support and resistance. Beyond that, the breakout and breakout ratios are higher.

Option Selling Strategies & View- So far, we had a worthwhile discussion with practical learning and pro tips about the best trading setups for signal leg trading. Now we are going to explore some of the most suitable and preferred option trading strategies for option writers.

Conclusion: In the world of options trading, both buying and selling strategies have their merits and risks. Options buying provides the opportunity for significant returns but carries the risk of time decay eroding the option's value. On the other hand, options selling can provide consistent income through time decay, but traders face the risk of substantial losses if the market moves against their position.

It's essential to thoroughly understand the strategies and consider various factors such as market conditions, risk appetite, and personal goals before choosing the most suitable options trading strategy. With a comprehensive understanding of the merits and pitfalls of buying and selling options, traders can navigate the market with confidence and increase their chances of consistent profitability.

The views and opinions stated in the content belong to V.L.A. Ambala, a Research Analyst (SEBI Registered) and Co-founder of Stock Market Today. Stock Market Today (SMT) is a stock market research (equity, derivatives, and commodities) and mentorship platform headquartered in Nagpur, Maharashtra, India.

Disclaimer

The recommendations made above are by market analysts and are not advised by either the author, nor Greynium Information Technologies. The author, nor the brokerage firm nor Greynium would be liable for any losses caused as a result of decisions based on this write-up. Goodreturns.in advises users to consult with certified experts before making any investment decision.