Before You Trade Options, Build the Trader

So finally, we’ll be talking about options a lot. The main purpose of this series, like I’ve pointed out in other articles, is to make sense of options and use them as a tool to limit our risk and maximise our returns. At the same time, we can also make options work as a source of passive income.

Options have become remarkably popular here in India, among retail traders, institutions and professional money managers alike. Still, in some quarters, the concept of options is treated with fear and trepidation.

When I was starting out as a trader, the advice I got was to stay away from options, because without proper knowledge they can ruin your trading career in the early stages. That’s true to some extent. Without proper knowledge, options can be very dangerous.

So whatever you want to make work, whether it’s cash equity, swing trading, option swing trading or options for risk management, you need to keep your expectations at a very realistic level. And you need a plan with a structure and a simplicity that you can follow every time. I’ve been trading for around 7 years now, and over the years my trading system has become simpler and simpler.

To make it as a trader, there are some very important traits you need to develop.

1. Patience
2. Perseverance
3. Knowledge
4. Honesty

Patience

If you’re new to the stock market, and to trading in particular, remember that you need to take your time. Just imagine: getting an MBBS degree here in India takes around 5 years. To become a specialist, you add another 3 to 5 years, and more still to become a super-specialist. So at the very least, it takes about 7 years to be called an expert in the field. The same goes for engineering and other technical skills. You need a mix of theoretical knowledge, practical knowledge and experience, and you need to give yourself the time to learn. That’s the first thing to understand.

If you want to get comfortable trading options, you might first have to get comfortable trading stocks. Once you’re comfortable with stocks, you can move into options much more easily.

We’ve all had the experience of jumping into an investment too early, even when we weren’t quite convinced it was the right thing to do. So be patient. Take a deep breath. If you have to slow down, slow down, and stick to your own timeline every time.

And please don’t compare yourself with the social media traders flaunting and posing on the internet. You have your own time. Trust me, many of them are just posers, influencers getting paid for affiliate marketing.

Patience also means choosing a trading strategy where time works in your favour, and where your downside is covered. In options, there are plenty of strategies to choose from. But as you progress in your trading career, like many of us who have gone through those phases, your strategies will get simpler and simpler.

Just imagine this: what small, steady gains compound into

Weekly return	Monthly	Over 3 years
1%	~4%	~372%
2%	~8.24%	2,000%+

At 1% a week, your capital grows to about 4.7 times its starting value in 3 years. At 2% a week, it grows about 22 times.

I’m pointing this out to remind you why you need to be patient. If you can compound small gains, the magic of compounding will do its work for you.

Perseverance

If you truly believe in something, you have to keep at it until you reach your goal. And once you think you’ve reached that goal, set another target. If you want to become a successful trader, whether full-time or part-time, you must stick to the plan you’ve laid out for yourself and get there. If I can do it, you can do it.

I’ve seen it time and time again with the people we’ve coached. We give them the framework, but only about 2 out of 10 truly stick to it. Very few.

So to be practical, give yourself attainable targets to reach in a realistic time frame. Keep going, and enjoy the process of accumulating.

Knowledge

To have practical knowledge, you first need theoretical knowledge. In science, you learn the theory and then do the practical. The same applies to trading. A lot of what you learn in trading comes from experience, of course. But if you harness all three, theoretical learning, practical learning and experience-based learning, that’s the most powerful way to learn trading.

So don’t limit yourself to practical knowledge alone. Besides the articles I write, read books and do the research yourself. Trade practically and build up experience, and try to learn from other people’s experiences as well. Apply all three, and I’m sure you’ll end up coming back to the simplicity I talked about earlier.

Honesty

Last but not least, you have to be honest with yourself if you’re going to develop into a decent trader or investor. Don’t lie about your results. You need the integrity, the honesty and the courage to truly reflect on your actions and your performance. That’s very important. If you’re not honest about your own results, you will never make it as a trader.

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Now, going further into options.

So what is an option?

An option, in its simplest form, is nothing but a contract. It’s very simple.

If we look at that definition, it has several parts.

The right, but not the obligation

You have the power to buy or sell an asset, but you’re not obligated to buy or sell anything. If you want to, you can. If you don’t, you can simply ignore it.

A fixed price (the strike price)

That fixed price is what we call the strike price. Say you buy a contract that lets you buy XYZ stock at ₹2,000 on a certain date. That ₹2,000 is the fixed price. Having bought the contract, you have the right to buy at ₹2,000 on that date, but not the obligation. If you don’t want it, you can choose to ignore it. That’s up to you.

Before or on a predetermined date

Here you have to understand that there are two kinds of options: American and European.

If you buy an American option, you can exercise your right to buy or sell the asset at the fixed price at any time on or before the predetermined date.

If you buy a European option, you can exercise that right only on the predetermined date itself.

Buyer and seller: right versus obligation

Buying an option gives you the right, but not the obligation, to buy or sell an underlying instrument, for example a share of a stock. You’re not obligated to do anything; you simply have the right to do it at a fixed price. When you buy an option, your risk is simply the price you pay for that right, the premium.

But if there’s a buyer, there has to be a seller.

Option buyer

• Gets: the right, not the obligation, to buy or sell the underlying.
• Pays: the premium.
• Risk: limited to the premium paid.

Option seller

• Takes on: an obligation to buy from, or deliver to, the buyer if the buyer exercises.
• Receives: the premium.
• Risk: selling options naked carries an unlimited risk profile.

So it’s very important to learn the difference between the two. Selling an option, whether it’s a call or a put, obliges you to buy from or deliver to the option buyer if he or she exercises the option they bought.

If I go further than this, it’s going to complicate a lot of things. So for now, let’s stay with the definition: if you buy an option, you have the right, but not the obligation, to buy or sell an asset at a fixed price, before or on a predetermined date.

That’s it for this note.

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