Options have evolved in ways that they works in favor of sellers, but wait its not for every seller, you have to have mastery in smelling market sentiments and then only you can use options to make trading robust. We will discuss more on options behavior without which one cannot become an option champion.
Options are hedging instrument, but in standalone trading, why are sometimes options preferred over stocks ? this is because options give you more time, as opposed to stocks where a losing position, necessarily create a emergency situation where one has to decide and act hast-fully, which means run stop loss before it becomes too large.
This emergency situation is eliminated from options trading which is a huge advantage, temporarily your position may come under loss but you are not really a loser unless the underlying price crosses the option strike on expiry day.
Day trading is chewing iron bullets – the style which option value change with underlying price, creates a very poor risk-to-reward ratio for sellers, this is due to the fact that when underlying price drops, corresponding option drops by logarithmic function and during rise its exponential rise, this makes them difficult to use for day trading, as when you lose its manifold than what you get in winning trades. Look at the diagram below which shows how option price adjust.
Historically Oom ( out of the money) options selling wins 90% of the times, so its only 10% trades are loser, now the tricky thing to understand in losses in an option trade are never small, it cannot be small, why?
This is because when selling you earn only small option premium, but when lose you always shell out the difference between underlying price and strike price which is completely in a different scale. Therefore those 10% trades have enough capacity to eat up all profits generated from 90% winners, sounds ironical…isn’t it !!
Another thing is options price do not drop during days when an important news is about to be released, so even if you get the direction right don’t expect options to generate profit for you.
A frustrating thing about options are, they do not carry one-to-one correlation with underlying value, and anyone who trades options by watching spot price will have disappointments, this is because underlying and options are abide by only strike and expiry date. in between options can behave like an independent instrument.