Option trading works well in a trending market and lets you make an awesome return. You may be heard about trading in options contract if you have spent some time in stock markets.
Trading in options is highly risky although we all know that high-risk high return and low-risk low return. Certainly, option trading lets you make more money than any other stock market products in a trending market.
Furthermore, you will also know the probable loss before you initiate any trade. That means you will know the maximum loss you will have before you set up your trade.
Trending market is nothing but moving in one direction whether it is bullish or bearish. Normally a bullish trend follows an upward movement of the stock market and a bearish trend follows a downward movement.
Trading in options in a trending market gives you higher return as compared to cash and futures segment.
Digging Option Trading
Options are normally a derivatives contract and its value is derived from other. You can trade either on stock or index options. Their values are basically derived from the spot price of the stock or index and are termed as a stock option or index option.
Options are again divided into “call” and “put” options. You can buy “call” option if you think that market or a particular stock will go up and their trends remain bullish. In case the market reverses its trends then you can buy a “put” option.
That means if a stock or index will move up then the price of a “call” option likely to appreciate and the price of the put option will be depreciated simultaneously.
Similarly if the price of a stock or index decline, then “call” option price will go down and at the same time “put” option price will start to rise.
Suppose, stock A’s trends are bullish and it likely to go upwards then its “call” option price will also go up and “put” option price will go down. However, if its trends are bearish then reverse will happen.
If it likely to go down, then “put” option price will rise and “call” option price will decline. Similarly, an index option will also behave in the same way.
Read also: Unfold Options Trading and Make Money Online
Key Differences in Returns on Equity, Futures and Option Trading
When I was writing this post, I found that stock “Mindtree’ in an uptrend and its spot price is 525. While in the future, it is trading at a premium of Rs. 3 that is its future price is 528. Its call option price is 3.5 having a strike price is 540 with a lot size of 1200.
Remember you can buy a future and option in a lot whereas you can buy a single stock also. So, now let’s calculate how much capital you may require and how much risk and return expected on the three instruments.
So, in this post, I have referenced the margin calculation from Zerodha only and the margin is different for different scrips.
For Mindtree Cash Segment
Total Capital = Spot Price * Total Quantity
= 525 * 1200
= Rs. 6,30,000
For Mindtree Future Segment
Total Capital = Spot Price * Lot Size
= 528 * 1200
= Rs. 6,33,600
However, in future trading, you need to pay only the margin amount that is 5% of the total investment capital of one lot. So, you need to pay only 28500 to buy one lot of Mindtree Nov future contracts.
For Mindtree Option Segment
In the options segment, you only need to pay the premium for the particular strike price. Mindtree is bullish and it is expected to hit 540.
So, you can buy its “call” having 540 strike price and its premium is at Rs.3.50. Here we have selected the out-of-the-money call option as the target price of spot price is 540.
Total Capital = Call Premium * Lot Size
Calculation of Profits
Summary of Trade on All segment
|Percentage ROI (Approx.)||2.85%||50.50%||171.50%|
In the above figure, you can see how much the percentage return on your investment has made in each segment. So, we have a winner that trades on an option and makes a huge return of about 171.50%.
On the other hand, trading is done on the future segment also generates marginally above 50%. In the case of cash trading by blocking nearly 6,30,000 we just manage to book a profit of 2.85% only.
So, finally, options trading is really a powerful instrument and if done it properly then you can make fortune out of it. I suggest you gather loads of knowledge before entering option trading.
It is much riskier than you can imagine and so, always do it in an uptrend or downtrend market or stock. Please avoid doing trading in options when markets are trading sidewise.
I hope this post will help you to get a fair idea of why option trading returns awesome in a trending market. You can express your views and suggestion in the comments section.
Published on: Nov 27, 2017