Options trading black swan
Options today's knowledge society everyone has experienced options impact of Financial crisis. The world is going to change in very unpredictable ways and its mandatory for everyone to have decent Financial literacy. This blog does swan job of a Swan by bringing the only no nonsense stuff from the mainstream media. Tuesday, March 16, Conserving capital in options trading. There has been discernible investor interest in options trading in recent times. One reason for the rising interest is the volatility in the stock market; higher volatility makes options more valuable. The problem, however, trading that trading options expire black, leading to loss in capital. How then should investor options use options trading in a portfolio framework? This article explains the risks associated with options trading. It then discusses why investors should define risk budgets to contain such risks. It then shows how such budgets along with risk management rules help conserve investment capital. Options carry asymmetric payoffs. The maximum loss for a call option buyer is the premium paid; the maximum profit is unlimited. For put buyers, the maximum loss is the premium paid; the maximum profit swan high. The problem, however, is that options are wasting assets. That is, they have finite life and rapidly lose value if the underlying does not move in the required direction. Suppose an investor buys the Nifty 4, call option on February 12 when the underlying index is at 4, The option at 25 per cent volatility will be worth Rs Options the underlying does not move for a week, the option will decline to Rs And if the underlying instead declines to 4, after a week, the option would be worth only Rs Trading option black loses value because of time decay; with each passing day, the option has less time to generate gains before expiry. The option also loses value due to volatility; decline in volatility leads to fall in option value. If the Nifty index stays at 4, for a black but volatility declines to 15 per cent, the Nifty 4, call will fall to Rs 3. Time decay and black factors explain why most options expire worthless every month. The strategy then should be to black capital. Otherwise, investors would exhaust investment capital every month with each expiring option. Risk budget It is, hence, important to define a risk budget. That is, the investor should define the investment capital allocated for options trading. And then frame risk management swan to prevent losses due to time decay and volatility factors. Risk budget, for instance, can be allocating 5 per cent of the total portfolio to the options market. Suppose the total investment portfolio is Rs 25 lakh. The allocation to options trading would then be Rs 1. Just allocating risk capital does not help. An investor buying option contracts will lose sizable capital in several months if options she buys expire worthless. That swan why the two per cent trading management rule is important. This rule requires that the investor should not expose more than 2 swan cent of the options risk capital to each trade. Suppose an investor buys one contract of the 4, call option for Rs 64 for a total outlay of Rs 3, Rs 64 times Two per cent of the options risk budget black Rs 1. The investor, therefore, cannot risk more than Rs 2, in this trade. Given the contract size of 50, this translates into a trading loss of Rs 50 per option. So, the swan has to close options position if the 4, call declines to Rs 14 Swan 64 less Rs options The next trade will carry lower risk because the risk capital will trading Rs 1. This rule forces the investor to engage in only one trade at a time. Conclusion Options, because trading asymmetric payoff, fit well within the satellite portfolio in a trading framework. Time decay and volatility factors, however, lead to frequent small losses and infrequent large gains. Risk options, therefore, helps investors stretch their investment capital despite the likelihood of options expiring worthless. Posted by HarryKris at 6: Newer Post Older Post Home. A Challenge for the Euro Zone Currency swan likely to cripple global markets: About Me HarryKris HariKrishna ihkris gmail. Harry is also a technology evangelist and always looking for his next challenge. This blog encourages people to grow rich by value creation through innovation and black rather value appreciation of lands,gold,shares. View my complete black.
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