Yesterday I made a decent 40% profit on the CALL option which I had bought a couple of days back. I started getting interest in option trading last year and followed market religiously. Index option of NIFTY has got decent volume and a volatile market like this could get fair return in the derivative side. The foray in derivative market was a good learning for me. Option market is good for those who have fair idea of economics, who do not get tempted and most important who trades in a market which follows logic.
In case of Indian derivative market, the volume is really thin as compared to equity market. The inflation reported to 42 month’s high at 7.61 on May 9th 2008, but the market did not move down for “some time”. Analysts came with opinion that the current inflation figure was expected and already accounted for. The market started falling after that and the opinion changed that the high inflation was causing the mayhem... On May 12th, the Index of industrial Production (IIP) number came, which was lowest in the last 6 years. Markets fell initially, but regained its loss in the second half with no positive trigger. Not only this, it closed surprisingly in green. Next day market fell by around 2% and the IIP number was blamed for such movement... The inflation on May 16th was reported as 7.83, the highest in last 44 months but market went up in spite of low IIP number and such high inflation. Same story gets repeated and market closes in green - about 0.50-1.0% higher than the previous day close. There are many such instances, which indicate that Indian market is rigged, does not follow logic and is well manipulated for the benefit of a few.
In such a scenario, whether derivative trading is sensible investment alternative or not is an issue to be debated. As per the report from Chicago & New York, between 80-95 % of the amateur players lose in the Futures & Option market. And these odds are worse than the worst odds at casino or at the racetrack. The large potential return in this market is attractive to many small investors who are not satisfied with getting rich slowly by investing in stocks for long term. They venture into the derivative market to get rich faster and eventually lose all their saving in a very short span of time. Options are only for certain period and get expired at the end of the period. One has invested in stock and his research suggests that price will come down soon, so he buys PUT option to hedge his losses. But price does not come down in this month. The option expires worthless and he loses all the money he had paid as the premium. To be protected continually, he has to keep buying PUT option every month which he can not afford to do. The worst thing happens when the sure thing proves to be true and the price of the stock comes down the next month. Not only he has lost his money, he has done it while being right about the stock. Instead of being rewarded he is wiped out from the market with very thin saving at hand.
Another sad part of the story is that these options are very expensive. The more volatile the market is and the more time-horizon the option has got, the higher the premium is. The Black-Scholes formula for calculating the premium of option suggests that NIFTY has got roughly 20-35% of volatility (Volatility index), which results in quite higher premium.
Options are zero-sum game, for every Rupee won in the market there is someone who lost a Rupee, and interestingly, minority does all the winning. Buying option has nothing to do with owning a share and it does not make one owner of the dividend paid by the company. One contributes to the growth of the economy of the country when he buys the share of stock even in the secondary market. But in options market, not a bit of money is put to any constructive use.
To sum up, trading in derivative is one of the riskiest investments. While stock itself is highly priced, the derivative trading could lead to major disaster. Warren Buffet referred these volatile, dangerous options as “financial weapons of mass destruction”. Small investors should be cautious of making investment in such financial instruments and should be rationale than being tempted.
In case of Indian derivative market, the volume is really thin as compared to equity market. The inflation reported to 42 month’s high at 7.61 on May 9th 2008, but the market did not move down for “some time”. Analysts came with opinion that the current inflation figure was expected and already accounted for. The market started falling after that and the opinion changed that the high inflation was causing the mayhem... On May 12th, the Index of industrial Production (IIP) number came, which was lowest in the last 6 years. Markets fell initially, but regained its loss in the second half with no positive trigger. Not only this, it closed surprisingly in green. Next day market fell by around 2% and the IIP number was blamed for such movement... The inflation on May 16th was reported as 7.83, the highest in last 44 months but market went up in spite of low IIP number and such high inflation. Same story gets repeated and market closes in green - about 0.50-1.0% higher than the previous day close. There are many such instances, which indicate that Indian market is rigged, does not follow logic and is well manipulated for the benefit of a few.
In such a scenario, whether derivative trading is sensible investment alternative or not is an issue to be debated. As per the report from Chicago & New York, between 80-95 % of the amateur players lose in the Futures & Option market. And these odds are worse than the worst odds at casino or at the racetrack. The large potential return in this market is attractive to many small investors who are not satisfied with getting rich slowly by investing in stocks for long term. They venture into the derivative market to get rich faster and eventually lose all their saving in a very short span of time. Options are only for certain period and get expired at the end of the period. One has invested in stock and his research suggests that price will come down soon, so he buys PUT option to hedge his losses. But price does not come down in this month. The option expires worthless and he loses all the money he had paid as the premium. To be protected continually, he has to keep buying PUT option every month which he can not afford to do. The worst thing happens when the sure thing proves to be true and the price of the stock comes down the next month. Not only he has lost his money, he has done it while being right about the stock. Instead of being rewarded he is wiped out from the market with very thin saving at hand.
Another sad part of the story is that these options are very expensive. The more volatile the market is and the more time-horizon the option has got, the higher the premium is. The Black-Scholes formula for calculating the premium of option suggests that NIFTY has got roughly 20-35% of volatility (Volatility index), which results in quite higher premium.
Options are zero-sum game, for every Rupee won in the market there is someone who lost a Rupee, and interestingly, minority does all the winning. Buying option has nothing to do with owning a share and it does not make one owner of the dividend paid by the company. One contributes to the growth of the economy of the country when he buys the share of stock even in the secondary market. But in options market, not a bit of money is put to any constructive use.
To sum up, trading in derivative is one of the riskiest investments. While stock itself is highly priced, the derivative trading could lead to major disaster. Warren Buffet referred these volatile, dangerous options as “financial weapons of mass destruction”. Small investors should be cautious of making investment in such financial instruments and should be rationale than being tempted.
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