How to make money by trading in futures and options
In an online chat with Get Ahead readers on October 9 Nithin Kamath, CEO, Zerodha.com answered readers' queries on how to trade in futures and options.
Here is the unedited chat transcript.
kaushal: What are the conditions imposed by SEBI for brokerages to start offering F&O services?
Nithin Kamath: SEBI does a rigorous check on background of promoters, networth requirement, market knowledge of the management, technology and risk management systems before allowing a brokerage to offer f&o, along with this there is continuous audits done by the exchanges to ensure that everything is in place.
ulfat: Who should ideally trade in futures & options segment?
Nithin Kamath: Futures and options requires some commitment in terms of time to learn how to trade and then tracking your trades once you have taken them. If you are a positional trader, then I guess a person who can commit atleast a couple of hours everyday. Also, the business involves leverage and can be an emotional roller coaster, so a person who can handle that volatility.
alex: Which books did you read to become an expert? What role does experience play in becoming a great F&O trader?
Nithin Kamath: Best books to get started with are those which talk about the good habits of profitalble traders as mentioned below. But once you are done with that, it is self discovery in reading and researching on what strategy best suits u.
Yep, experience is the key, important thing is to learn from your experience and not make the same mistake twice.
Jeswal: How can I become an expert in F&O trading
Nithin Kamath: f&o trading or trading in general requires a lot of time effort and dedication. The only way to learn trading is by actually putting up your money, only then will what you read make sense. But it also important that the money you put is something you can afford to lose. As I said earlier, try reading about what most profitable traders in the world did right in the book Market Wizards.
kapadia: premium for which strike prices have high implied volatility? What does it imply and how to make money using this high implied volatility?
Nithin Kamath: Usually out of the money options have a higher IV, the trade typically could be if it is much above the mean IV, it could be a good time to sell them and much below the mean time to buy.
Tharun: If i sell a call on starting of month ex.18 rs/-, when it reaches to zero on expiry,so i get profit of 18 rs? How can i calculate margin required for writing a option?
Nithin Kamath: We provide a tool called SPAN calculator, http://www.zerodha.com/z-connect/blog/view/span-calculator this allows you to calculate. We will be soon providing a similar tool on our website which can be used by everyone.
vinod gatta: what is the average oscillation range of IV in nifty option? how can we use of it by analyzing?
Nithin Kamath: Don't have the exact numbers but the range is between 10 to 40, at the lower end better to buy options and at the higher end to write them hoping that it will revert to the mean.
sudaram: What is historical or statistical volatility? How does it affect pricing of futures and options?
Nithin Kamath: Historical volatility is simply historical volatility in the price of the underlying. Volatility affects options more than the futures, higher volatility usually would mean option would be priced higher.
John: Are Indian F&O mkts deep enough? there are no calll writing and put writing for next month or 3-month F&Os...
Nithin Kamath: Yes liquidity is pretty bad if you go for anything other than present month. Also the activity in stock options is really low.
jitesh: How shall one trade in the F&O of index heavyweights on the expiry day?
Nithin Kamath: There is no preset strategy to trade on expiry day, all you have to be careful is about not letting your in the money options expire (you rather sell it on the exchange rather than holding it till the close of trading on the expiry day. The reason for this is because the STT on expired options which are in the money goes up significantly.
omi: How does a call writer and put writer make money?
Nithin Kamath: call writer makes money when the markets don't go up above a certain point and put writer if market doesn't go down below a certain point.
rajat: plz enlighten us on 5 must-dos and don'ts while trading in F&O
Nithin Kamath: The most important rule while trading f&o is to be very conservative, since there is a risk of losing money fast, risk only that which you can afford to lose, ideally should not exceed more than 15 to 20% of your investible capital.
bhanu: what is implied volatility mean? How can I calculate it?
Nithin Kamath: IV of an option contract is the value of volatility of the underlying instrument. Most trading platforms have an in built tool to calculate IV, this is typically using the Black Scholes model.
Gadgets-Gaming: Tell me what are the risks associated with F&O and risks with day-trading in stocks?
Nithin Kamath: Risks associated are the same, since you are trading with leverage, i.e more money than what you have in your account, the risk of losing money fast if your trade is not right.
shaishav: Is it advisable to buy calls and puts or sell them?
Nithin Kamath: It is advisable for a beginner trader to start off buying options rather than writing/selling them. Once you get a hang of how the business works, you can look at writing/selling them as well.
shinde: How can I make profits on results day. A lot of benchmark stocks will be announcing their results starting october 11.
Nithin Kamath: As mentioned in Anil's query earlier, buying both calls and puts is the best bet when expecting volatility in the markets.
mustafa: How is trading in futures & options differennt from trading in stocks? What makes more money?
Nithin Kamath: Trading in f&O basically lets you get over the basic limitations of trading stocks. 1. it can be used to hedge, similar to insurance policy for your portfolio 2. Speculate, while trading stocks if you feel stock/market is going down, you can sell and buy back only for intraday, whereas in f&O you can run this position upto 3 months.
Also while trading stocks if you want to buy for more than what money you have, there is an interest to worry about, but not in case of f&o
vishal: What are the kind of money one can make in F&O? What are the risks attached?
Nithin Kamath: Since when trading on f&O, you get a leverage, the profits you can make also gets multiplied. But leverage is a double edged sword, so the risk also goes up quite a bit.
salim: I have heard about straddles and strangles in F&O. But how do they help me make profits? What are the risks associated with such strategies?
Nithin Kamath: Straddles and strangles are option strategies that you can take when instead of direction of the markets, you are betting on the volatility. Safer than naked options trading because your risk is hedged.
shirish: I want to trade in stocks and also F&O. Which are the best books to read?
Nithin Kamath: The best way to start off trading markets is by knowing what the profitable traders do, so in that context Market Wizards by Jack Schwager is a good way to start.
Photographs: Uttam Ghosh/Rediff.com