May 20, 2014

Question: options vs futures in a bullish market

Question posted by site visitor:

I too share your bullish stance on nifty & bank nifty. With both these indices making higher tops & bottoms as they do in a bull case market, will the strategy of buying and holding out of the money call options till expiry of each month work? If this strategy does not work, could you please suggest how one could play these indices by buying call options as they have limited risks when compared to futures.

Your views on this.

Dinesh Babu

It is a myth that options have limited risks as compared to futures. I would in fact consider options quite dangerous.

This is because the way an option is designed, everything is against the buyer... for eg., time decay, volatility and market movement. This also means that everything is in favour of the option writer.

When used correctly, options can give fantastic results but statistics show that globally retail is always losing in options. By same logic, option writers are almost always winning.

Buyers wrongly assume that just because you are paying only the premium when buying an option, your risk is limited because you cannot lose more than what you hve paid. But time decay and the fact that markets may not move or IV drops, means that your entire principal or investment may come down to zero. Because on expiry, time value of options is zero.

This is not the case when you take a position in futures. Here your risk is only because of leverage. You are not affected by time decay or drop in IV. Also, if the market is rangebound for few weeks, you are not losing anything whereas you are losing a small money everyday in options.

In current context, market is expected to have strong resistance at 7500 and support at 6500.... this is appearing in JUN series also. This means markets are likely to be rangebound for quite some time. If true, the only option is to wait for a correction and then buy a call subject to the then prevailing trend.

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