Futures and Options Trading might land you in Bankruptcy

Overview:

The stock markets have been around for more than a century. Primarily, stock markets provided the platform to common people who save their income, and retail investors willing to get into businesses. In the early 1900s, investors put their money in stocks with good fundamentals and financials. Derivatives like futures and options did not exist in those days.

They followed the concept of money that is invested in a good stock provided more returns than a bank deposit or a bond. And those were the days when dividend yield from stocks easily outperformed the interest rates and bond yields. Investors held onto the stocks for multi-years if not decades.

Somehow, people realized the magic of trading stocks and making more money in relatively very less time. When something new comes into existence, the strongest community makes most of that. In Wall Street, the dominants like corporate CEOs, stock exchange heads, stockbrokers, and financial magazines made the most. All they had to do is to inflate stock by buying it aggressively; it creates artificial demand for that stock.

When such a price action happens in any stock, retail investors purchase it for a high premium. After luring the retail investors into the trap, the elite folks successfully exit the stock making huge capital gains. As the extensive withdrawal of money takes place, the shares tank to the lows. As usual, retail investors always lose money chasing such hot tips.

Introduction of derivatives:

Today’s stock markets are all about manipulation. People are making money predicting the rise or fall of stock prices. If you feel what happened in the Wall Street in 1929 was a great manipulation, just try trading in Futures and Options. You will smash your heads why a stock option price varies by 300% in a single day. In the end, it will give you sleepless nights. Unfortunately, 99% of all retail options traders lose money.

Derivatives seem like the best earning opportunities for a new trader. Believe me, I was expecting to make ten times what I made trading stocks. I would have made those profits if I had stuck to those positions over the tenure till the expiry. You might question, why did I exit the positions then?

Over the next few days, my portfolio showed me a loss of over a hundred thousand rupees. When you see that astonishing amount in the losses column, you will take a psychological hit. All our dreams of making lakhs of rupees trading futures and options diminish. You just want your money back or at least whatever you can get back.

Eventually, when you exit the position, that’s when the magic happens; the options prices move exactly how you had predicted. It happens to almost all retail traders. It’s not rocket science to predict the movement of any stock or index. You might feel that I am boasting of myself, but I predicted 90% of my portfolio stocks’ price movement over a month correctly. Many financial websites make it sound as impossible. The options prices swing so violently leaving a poor retail trader clueless and intolerable to hold the positions any longer.

Most Common Derivatives in Stock Markets:

Futures:

A futures contract is a legal agreement to buy or sell a particular commodity asset, or security at a predetermined price at a specified time in the future. The buyer of a futures contract takes the obligation to buy and receive the underlying asset when the futures contract expires. The seller of the futures contract takes on the obligation to provide and deliver the underlying asset at the expiration date.

Options:

Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell, depending on the type of contract they hold the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to.

What if I hedge my positions?

Hedging your positions is the best way not to lose huge money in futures and options trading. Most of the hedging positions go this way. You either buy or sell an option at a certain strike price and then do the exact opposite at another strike price.

For example, if you buy 9800CE at ₹200/- and sell 9600CE at ₹300/-. If Nifty expires at 9700, you lose ₹200/- spent on 9800CE and you gain ₹200/- on 9600CE. Obviously, you earned nothing. It is not this simple and it’s just an example.

There are some options strategies like straddles and strangles, and professionals make a lot of money using such strategies. Whenever you sell an option or future, a considerable amount is locked from your trading account.

For instance, if you want to short Nifty options, the margin locked is around ₹140000/-. If you buy some options at another strike price, you will get some margin benefits. Either way, it is not recommendable for small traders who trade with ₹3 or 4 lakhs capital. With so much amount locked, we can’t trade further till we exit the positions.

What about option trading Gurus on YouTube?

I follow some of the futures and options traders on YouTube and try some of their strategies as well. Some of them claim to make ten lakh rupees or more in a single trade. I used to feel, Wow! That’s more than what my whole family makes in a year. He just did that in an hour!

Then a question arose, if he makes ten lakh rupees daily trading options, on average he should make more than ₹2 crore (20 million) every month. Believe me, I am an occasional trader, and I don’t find time to write these articles. So I manage only two articles in a week.

How come some person who makes ten lakhs in a single trade has time to post a video every day? Why does he want to share his secrets with everyone? When I checked these people’s websites, YouTube channels, and blogs, I found lakhs of subscribers. Some of these people’s training academies charge ₹40000/- for a single course.

I still don’t understand, if they make crores of rupees in trading, why do they collect fees from students or new traders? Or if they want to help others, they could do it for free since they are earning so much by just trading.

So it’s up to you to understand what’s really going behind the screens. Maybe they are making more money selling shovels rather than digging gold.

My final views:

I am not entirely against futures and options trading. If you have a strategy with a stop-loss, you can trade in these derivatives. But again, trading is not a hobby or an interest, it is a profession.

Usually, people don’t make much money just being a part-time option trader. For the last three months, stock markets are going berserk. Only the professional traders with large capitals (in millions of rupees) and those working with High Net worth Individuals (HNIs) have the edge. They receive the news and other data which an ordinary trader like you and I won’t get.

Also, some people believe that technical analysis always works. Then, why couldn’t they predict the stock market crash in March? It would have saved small investors like me. I find some videos making fool out of their subscribers. They predict that Nifty to find resistance and support at a certain level.

At the end of the video, they clearly mention it is only an assumption. Which means it may or may not happen. They post another video if Nifty behaves according to the previous assumption, bragging about their expertise. They keep quiet if their assumption fails.

You might feel that you have done great research using charts, technical indicators, and FPIs buying & selling. If you can do that much with limited information, just imagine what can a highly advanced algorithm with every inch of data being fed into it could do? It will easily outperform any one of us in the short term.

So, an ordinary investor should stay away from futures and options trading. Believe me; it took me more than a year of experience in options trading to say these words. If you use a huge margin like 5X or 10X, there is a very good chance of your portfolio getting wiped out in a single day. Some high net worth traders gloat that trading is not for fainted hearted people. But it’s not true, options trading is not for small traders with little capital and little expertise.

Note:

I provide the information and my views on the website only to educate new investors, stock market enthusiasts, and the common public on equity or stock market investments. Please consult your financial adviser before making any investments in the stock market. In case of any queries, you can contact me via email ID: shivakumar.lachapeta@valueinvesting.online.