3 known pitfalls in options trading, including STT ahead of F&O expiry

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There are only two things certain in life “death and taxes”. It is true but the list could be augmented for Options Traders as well.

Unlike the usual discussion on how to tame market uncertainty, let us today talk about some of the elements of Options Trading, which if overlooked could definitely lead to a dent in profitability.

We will consider three such elements followed by a precaution or a way-out to safeguard from each one of them.
Shubham Agarwal

Shubham Agarwal
CEO and Head of Research|Quantsapp Private Limited

Number 1: STT (Securities Transaction Tax)

I am starting off with ‘taxes’ to take the list forward. Normally, STT is not a big figure to be reckoned with during the expiry but on the day of expiry, it turns really big for a certain set of options.

All the in the money options meaning, Calls of strikes lower than the current market price and Put with strikes higher than CMP would “If let to expire” attract STT = 0.125 percent of Contract Value (Strike + Premium) * Lot Size for the buyers of the Options.

Now as intelligent as the market participants are, they start discounting this in the final hours of the expiry making a trap for us.

3 known pitfalls in options trading, including STT ahead of F&O expiry

Meaning 27,000 CE with Bank Nifty at 27,100 should be trading at least 100 (Intrinsic Value) but starts trading at 85-90 discounting a probability of an STT levy of ~34/- (=27,100*0.125/100).

Solution: Please do not indulge in Buying of ‘In The Money’ Options on the day of expiry towards the end of the day.

Number 2: Event Trading with Long Options

As we all know that Known Events like Results/Announcements for Companies and Elections/Policy decisions for Indices bring in expectation of turbulence. This gets priced into the Options as they start trading more expensive than usual.

Now, this helps the Options Buyers up to the day of the event, once the event outcome presents itself, the unknown becomes known.

As a result, we see a dip in all the Option Premiums regardless of strikes and expiry. This phenomenon creates a dent in profitability despite of the fact the view on the underlying is correct.

Solution: If we are expected to hold on to the Bought Options post the announcement, have a combination in place so the systemic and more certain drop in Premiums does not hurt as much.

Number 3: Options for Longer Horizons

We have discussed many times about the time value element and the fact that due to time value decay in Options there is a certain decay in Option Premiums with the passage of time.

Many times, a trade took on a Thursday if materializes on coming Tuesday, the actual trading sessions are just four inclusive of both the days but a number of days passed by are about six.

Catch: Time Value Decay is for each Calendar day and not just the Trading Day.

Solution: Keep the Options Bought under vigilance with Dual Stop Loss of Time and Price. Resort to a combination of a Long and Short strategy if the view is expected to be panned out over a longer period than three-four days.

Keeping the known demons tamed may not add to additional profits but will certainly lead to Error-Free Trading.

source: moneycontrol