The article discusses the basics of Singapore options trading. Options are unique financial products that are different from traditional stocks, futures or currency pairs in terms of how they behave. They are complex but offer new ways to invest for risk-averse traders who can afford some time to study it. As with most complex financial instruments, a learning curve is involved in trading options successfully.
Here are some tips that beginners should bear in mind when they enter the world of options trading:
Realise that every option contract covers 100 shares
Singapore Exchange lists many companies with their shares tied to an option contract. These represent what is called ‘derived securities’. For example, if you wanted to buy DBS Group Holdings, you would have to buy its option with the code ‘DBS’.
Look for liquid options.
Liquidity is essential in all financial markets. Liquidity refers to how assets can be traded in the market. When trading listed options, you should look for liquid contracts that are actively traded at a high volume so that you can exit your trades without any problems.
Keep your position size small.
The best way to learn about risk management is by starting with small contract sizes and building up from there as necessary. If you find yourself losing more than 5% of your account value per trade, you need to adjust accordingly by reducing your position size. However, if your strategy calls for larger contract sizes (e.g. ten or more contracts), you will need to trade with a more extensive account.
Don’t be afraid of expiring.
It is usual for options traders to be afraid of contracts about to expire. However, this is not something that you can afford to fret over too much, as the price action leading up to expiration has already determined your course of action. As long as your reason for trading an option remains valid, there is no need to stress out about its expiration date at all!
Out-of-the-money options expire worthless.
An out-of-the-money option has no intrinsic value because it would take a very bold prediction on the direction of the underlying security for the option to make money. Since an OTM is unlikely to profit, it expires worthless, and its owner loses his entire investment.
Buy at-the-money (ATM) options
An ATM option has more intrinsic value than an OTM one since it’s just as likely to appreciate as it is to depreciate. They are generally bought on speculation that the underlying security will move in either direction and therefore offer better chances of making a profit on price movement.
Treat Covered Calls like fixed income instruments.
A covered call called a ‘buy write’ can be considered similar to investing in fixed deposits because your capital is not at risk. Covered call options are often used by traders who have the cash they do not mind ‘parking’ somewhere with a tiny chance of making a small return.
Pin the strike
Singapore Exchange allows you to sell options without owning them first, called ‘naked selling’. However, this has its risks as the most likely scenario is for the price of your option to fall – in which case, your losses could be unlimited if it falls far enough. It would be best if you pinned its strike price by buying back the option before it expires to avoid that possibility.
Short straddles and strangles
Some consider a short position in the market to be easier than buying, although it can also incur significant risk. Selling options without owning them first is called ‘naked shorting. You can do this if you think underlying security will remain flat or move only slightly.
Sell the most expensive options.
Most traders who sell options do so to collect a premium, and it is not surprising that they would prefer to sell ATM and OTM contracts for this reason. After all, if you can receive a higher amount of premium for selling at-the-money or out-of-the-money options, why wouldn’t you?
