Although they’re riskier than equity, derivative contracts like futures and options are a great way to leverage the price movement of assets to your advantage. If you’re interested in trading in such instruments, here are some F&O trading tips that you can use to increase the chances of your trades becoming profitable and prevent market downsides from hurting your wallet.
In the case of options contracts, there are three different kinds that you will encounter - In The Money (ITM), At The Money (ATM), and Out of The Money (OTM). ITM options are the ones with strike prices lower (higher, in the case of put options) than the current price of the underlying asset. ATM options are the ones with strike prices near the same as the current price of the asset. And finally, OTM options are the ones with strike prices higher (lower, in the case of put options) than the current price of the underlying asset.
Trading in ATM or ITM options is always advisable since they tend to be the most liquid. However, the premium of such options is generally very high. Due to this, traders tend to gravitate towards OTM options, whose premiums are usually very low. However, they also tend to be illiquid and can cause issues when trying to square off your positions. Therefore, it is always a good idea to simply stick to trading in ATM or ITM options.
This is easily one of the most critical F&O trading tips you must follow. Volatility in the underlying asset, whatever it may be, can significantly influence the prices of futures and options contracts of the particular asset. And sticking with a position for far too long, whether the position is making gains or losses, can lead to a dangerous situation.
That’s why it is crucial to set strict profit targets and stop losses. Profit targets will ensure that you exit the position as soon as you’ve achieved your targets and prevent you from going into losses due to a sudden reversal in the price. Similarly, stop losses will drastically minimize your losses if the position doesn’t move according to your expectations.
This is another one of the many important F&O tips that you need to know. Most beginner traders, in a bid to increase their profitability, turn to trading in naked options. Naked options trading or uncovered options trading is when you trade in options without holding the underlying asset in your portfolio. This can be very risky if the asset doesn’t move according to your expectations. Here’s where covered options can help. Covered options trading is when you possess the underlying asset in your portfolio and take up an opposite position to hedge the risk. Here’s an example to help you understand how covered options work.
Assume that you expect the share price of Reliance Industries to go up shortly. To that effect, you buy 100 shares of the entity at Rs. 2,500 per share. However, to protect yourself from losses due to a downside, you choose to buy put options at a strike price of Rs. 2,500. By doing so, you essentially lock the price of the asset. Now, if the price of Reliance Industries falls below Rs. 2,500, you can simply exercise the put option and sell the shares at that price, reducing your loss significantly. On the other hand, if the share price rises according to your expectation, you can simply choose to let the options expire.
Trading in covered options can significantly limit the risk, which is not the case with naked options.
So, there you have it; these are the 3 F&O tips for today. Follow them diligently, and you can ensure that you safely trade in derivatives. That said, whether you wish to trade in the F&O segment or invest in upcoming IPOs, having a trading and Demat account is mandatory. So, if you don’t have it, get in touch with Motilal Oswal today to open a Demat account and a trading account within a few minutes.