It is a tool to be employed after studying the Technical set up of any market/ stock.
Before using options as a tool, you need to understand what are the option's characteristics and what it is made of:
Characteristics of Options:
Option premium, as its price is called, is based on firstly the "Time element" - start of the series the time element is high and hence a high premium and closer to the end of the series lesser premium as time element becomes quite less. This fact is used to write options if the market is expected to be in a range or in a sideways mode.
The second factor that determines the premium of the option is the technical set up of the underlying stock or index. If it is trending up. option premium increases and if it is trending down, option price decreases and if it consolidates in a sideways mode, option premium moves in a range but loses its premium due to "time decay".
The most important aspect of options is that its premium tends to outrun the underlying stock/ index when there is "frenzy in an upmove" or "panic in a downmove" and option players can take full advantage of such "Premium excesses".
Having understood its working, its useage will be relatively easy provided you discriminte its usage.
Few examples of Highly successful implementation of "Option strategy" in recent times are:
1. On 11th.Nov., JNSAR triggered a sell @ 6260 after serious negative divergence in the "Weekly TA". 6100PE & 6000PE would have become 5 to 10 times as the November settlement ended @ 5800. Alternatively one could write 6000 & 6100CE as the time window was favourable to capture the time decay even if the downtrend does not unfold but a sideways with a down bias emerges.
2. On 1st Dec., JNSAR triggered a buy @ 5880 after positive divergence in the "Hourly TA along with highly oversold daily TA". 5900CE & 6000CE if entered at that moment would have doubled in value. Alternatively one could write 5900 & 6000PE as the time window was favourable to capture the time decay even if the uptrend does not unfold but a sideways with a upward bias emerges.
Principles that are essential to follow are:
1. Always buy a minimum of 2 options and part book on one and Hold the other one till the "reasons to hold" lasts.
2. Choose the option strike price appropriately based on likely targets, time left for the series.
3. Never be greedy to risk with "Big quantities" as larger the size of your position, more difficult to stay objective. This helps you to stay in the game and play long innings. Get rich slowly.
4. Get Greedy when you spot a larger time frame suggesting a trend reversal as it happened on 11th November 2010 with "Weekly reversal". Such reversals are to be followed with "BUY & HOLD".(PE)
5. Keep it as simple as illustrated here and be patient enough to "Wait for a proper trade set up" to emerge while doing NOTHING during the wait.
6. You may lose a lot of your capital if you start trading the smaller moves using Options though some experienced traders manage to do well keeping their expectations under control. AVOID it.
Remember the Golden Goose Story and allow the market to show you those "Golden trade set ups" and get rich steadily.
Contribute:The above write up is a brief introduction to the powerful financial tool often misunderstood and illused by many. I would welcome contributions from "Open Interest(OI)" experts on the study of OI, volume & prices to arrive at strategies to "Write or Buy Options" at certain junctures and hold the same and other such relevant inputs. Share your experiences that have produced good results as well as the ones that has deceived.