What are the Option Trading Basics every trader should be aware of?

What are the Option Trading Basics every trader should be aware of?

Understanding the basics of options is very important for every trader even if you are not into option trading as it helps you in various ways.

Here is the list of things every trader should be aware of:

Option Buying:

Generally option buying has Low Risk and High Reward, because when you buy options your maximum potential loss is the premium paid, whereas maximum profit potential is unlimited.

So risk is already known clearly, whereas reward is unlimited, hence option buying is generally called as low risk, high reward trading.

Option Selling:

An option buyer had the benefit of low risk and high reward. So what is the benefit of option selling?

Odds. Yes, you heard it right. Option sellers has odds in their favour as odds of winning is around 90%. Only impediment  is the huge capital required for selling options.

So typically Option Trading is a game of Risk vs Odds. For an option buyer, risk is low and reward is high, whereas for option seller odds are in his favour.

High Volatility Events (India Vix):

Generally, volatility has an impact on the option premium. If volatility increases, option premium increases and vice versa. Focus on option buying before high volatility events to reap this benefits.

Power of Theta (Time Value):

Just like volatility, Time (or) Theta has an impact on the option price as well. Time value decreases slowly in the first half of the month and it reduces quickly in 2nd Half of Month. It actually melts down on the expiry day.

As an option trader, you can take advantage of Theta by focusing on Option Buying in the first part of the month and option selling in the second part of the month.

Selling naked Calls and Puts:

Selling naked calls and puts has unlimited risk but profit potential is limited. So as a professional trader, you should never do this.

Notes:

1. When you sell option close to expiry, always use 10% Buffer from MaxPain.
2. When you focus on selling options on just one side, avoid writing PEs and target CEs as fear spreads faster than greed.