Why everyone can’t become an options whiz

With the stock market offering easy gains during Covid, there’s been a surge in interest in options trading. Many folks who recently opened their demat accounts seem to believe that options trading is a good way to mint money while chilling at home without a day job. Paid options webinars, YouTube lessons and Twitter handles of charming young ladies who promise to hand-hold you through trading, have made it seem as if anyone can be a wizard at options.

But seasoned full-time traders, and those who’ve given up on it, tell us that relying on options trading for livelihood is an extremely stressful pursuit that can cost you both money and peace of mind.

It isn’t easy money

New stock market investors often get drawn to options buying because they can acquire large positions with a small initial outgo. Buying Reliance Industries share in the cash market costs you ₹2,420, but you can take a punt on Reliance rising to ₹2,500 in the next 20 days, by buying call options at a premium of just ₹30 per share.  

But looking at options trading in this simplistic manner is faulty. When you acquire a right to buy a stock at less than 2 per cent of its price, you’re effectively taking on a leveraged position. Leverage amplifies your profits on winning trades but also multiplies your losses on losing ones.

When you take a buy a Reliance call at a 2500 strike, you’re not just betting on the stock price going up, you’re also betting that the stock will gain more than your premium and that it will do so in 20 days’ time (expiry date). Therefore, for you to make money from such a trade you’ve got to get all three variables right. This is precisely why 70-80 per cent of option buyers inevitably lose money, as their contracts expire worthless at expiry. Buying options without any strategy in place is as good as flushing your money down the drain.

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The brass tacks of options trading

If options buying offers low probability of making money, the odds are better on the sell side. But option selling is more dangerous because of its limited scope for gains with unlimited scope for losses, if the stock goes up or down beyond all reason.  You can curb losses with a stop-loss or a hedged strategy, but that calls for discipline and willingness to forfeit profits. Even with such rules in place, seasoned options sellers talk of Black Swan events gobbling up many months of profits in a single day.

While options gurus on Twitter and YouTube may tell you that such risks can be easily managed through strategies and rules, greed is a powerful influence on the human mind. Newbies on a winning streak begin to think that they’re skilful traders and take on outsized bets that lead them to ruin. Those on a losing streak fall prey to revenge trading, where they take on irrational risk to claw back their losses from ruthless Mr Market. 

Traders who’ve stepped away from options recount emotional scars from their losing streaks. Not just ruined holidays and sleepless nights when positions weren’t going their way, but also strained relationships and psychological issues like temper tantrums and binge-eating. Avoiding such tendencies requires iron discipline. Successful traders talk of the many years it took them —- after blowing up their accounts once or twice — to master these emotions and to distance their egos from their trading results.  

Knowledge and systems

To the uninitiated, dabbling in options looks as easy as buying lottery tickets. You pay a small premium and either end up with a jackpot or lose your ticket price. While this approach is okay if you’re looking on trading as a hobby, to generate regular income from or make serious money, you need a trading system with a good win rate. This calls for serious skills, time and effort.  

Do you track the stock markets closely enough to predict how it is likely to move over the next week or month? Are you a whiz at technical analysis? Are you on top of macro global and local events that can cause big market moves? These are essential skills for you to take the directional calls that are the essence of options trading. But they aren’t enough.

To pick the right contracts to bet on and improve your win rate, you also need to understand how the option strike price moves with the underlying, whether the contract carries high or low volatility and the rate at which time decay is melting your premium. All this requires a good understanding of the math that goes into option Greeks, explained in Big Story. Those who’ve succeeded at options trading are often those who’ve perfected their skills at reading technical charts, assessing probabilities and doing nimble mental math to respond to whimsical markets.

As tracking all the variables that can move markets is a tall ask, most successful traders over time specialise in just one or two contracts and evolve a clear rule-based system that triggers their entry and exit, side-stepping emotional calls. Successful traders say that developing a winning system they have high conviction in, which could survive multiple market cycles, took 4 to 5 years.  

New investors hope to cut short this process through paid webinars, Youtube videos or Telegram channels that offer live trading tips. But these short-cuts seldom transform laymen (or women) into brilliant traders. For one, webinars can only teach you the principles of options trading and cannot train you to handle your emotions. Two, when ‘professional’ traders share their live trades with legions of followers, you need to ask whether this is purely out of altruistic motives or to amplify their own profits through front-running. If an options trading system is really minting millions for someone, you also need to ask why she is so generously sharing it with you for a nominal fee.  Seasoned traders say that making one’s winning system public is shooting oneself in the foot because, because if hundreds of others pile on to it, executing the strategy and profiting from it becomes an uphill task.  

Managing the risks

In leveraged trades, it is how you manage risk that eventually decides if you hang on to your profits or proceed to lose it all. Therefore, traders who’ve built up substantial wealth from options do much more than setting stop-losses or using hedged strategies for their trades. Mindful of one-off events that can wipe out their hard-won capital, they sequester their capital in safe instruments, deploying only 10 or 20 per cent in trading at any given point in time. They also set limits of 2-3 per cent for the capital that they would bet on a single trade.

While traders who are early in their career prefer to put their entire winnings back into the market in a bid to compound it, more seasoned folks talk of periodically withdrawing money, to convert the paper money into real assets. Pulling out your option gains and investing it in lower risk options such as debt funds, bank deposits or even index funds is one possibility. Because of the high risk-taking on options, some seasoned traders even prefer to invest the rest of their money in uncorrelated assets or ultra-safe avenues be it gilts, gold or real estate.

And yes, almost all of them warn that it is best not to rely on the ‘income’ from options trading for one’s living expenses. Even if you’re looking to be a full-time trader, an ancillary source of income from a side-gig, a working spouse or a rich uncle, is essential for stress-free trading. 

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