I mentioned in my last post that I bought a Put option on Tata Steel. Now notice how much the 510 put option has fallen today. From Rs. 12 at yesterdays close to Rs. 2.4 closing today. That’s a loss of 80%!

(This option is the right to sell Tata Steel at 510. I bought it when the stock was doing 505 so it was “in-the-money” then, not considering my premium. It closed at 533 today)

And the figures are grim. You can’t buy just ONE share – you have to trade in lots of 675 (the number differs for each stock). Now, this is a loss of Rs. 9.6 per share, so for one lot you would have lost Rs. 6480 in one day!

Okay, I’ve lost that much. And I know this: I am a stupid investor, making the most common errors. I will try to learn of course, and tell you what I learnt, so you don’t make the same mistakes.

Ddue to reasons of having actual work, I missed opportunities to sell the put and lower my loss. Unfortunately, I can’t blame anything else – this is the price I pay to learn.

Was this my first exposure to options? Not to index options – which I buy and sell Nifty options fairly regularly since my opening of a Reliance Money account which has extremely low brokerage. But it was my first exposure to single stock options.

The options are extremely volatile. In general options can move around 10-50% in a day, and usually do. I should have been more careful- and watched the put move around a day or two before I placed my order.

Second, this was an aberration of sorts. Tata Steel is up 5% in the day. This kind of movement does not happen regularly – in fact it hasn’t happened like this in the past few years! So I should not let a one time movement of this sort affect my broader judgement.

I also forgot to consider that the option expires on 26 April,next Thursday. At that close a point, buying out-of-the-money puts needs more research. My research may be sound, but it may not impact the market in one week! Perhaps I should have waited.

And finally, I have learnt that trading options is not something that you do without serious time devoted. Given the high volatility, you should track the option closely and take out your losses earlier (and also, book gains faster). This does not mean close stops, it just means that the time between buying and selling should be small. Options decay over time.

So, lessons learnt:

1) Your logic may be sound fundamentally, but it may not pan out for options, which have a shorter duration of existance. Nothing in Tata Steel will change till next Thursday so my entire analysis has no relevance to this month’s option. Tata Steel is still a sell, but not on this month.

2) I should have sold the future instead. Yes, that needs me to keep more as premium, but that also means I can roll it over to the next month in case the share price doesn’t move down. (You can’t roll over options you buy)

3) Don’t ever trade options unless you have the time to track them.

4) Options are very very volatile. Setting close stop losses in options is stupid – you will get stopped out with the volatility. Setting far stops is much higher risk, so you should choose a lower premium option. If I had chosen the 480 put instead of the 510 put I would have lost just Rs. 1,500.

5) Don’t blindly buy an option just because it looks good. Watch the way an option moves, at least for a couple of days, before you take a decision. At least if you are investing in single stock options for the first time!

6) Tata Steel’s rise today was not something that happens everyday. So this shouldn’t discourage me (or you) from understanding option trading.

Futures and options are very interesting. Typically futures involve between 25,000 to 50,000 of margin per “lot” and it’s not money gone down the drain, it’s money that’s with your broker who will return it when you square-off or exercise. Selling options (or “writing” them) involves the same kind of margins, but buying options just involves paying a premium (which you don’t get back).

Nifty options involve small premiums – a lot of 50 Nifty can cost you just Rs. 1500. That’s probably a better thing to use to learn.

But a series of small profits can be wiped out by one big loss, as I learnt. it’s time to use the golden rules of trading: Risk, Allocation and Money Management. I got them all wrong this time. But I’m learning.

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