The trend of trading deep out-of-the-money (OTM) options is gaining rising popularity in India, specifically for implementing market tactics, hedging, and gaining income from market fluctuations.
Buying options that are deeply out-of-the-money (OTM) is often blocked by numerous brokers in India.
Let's delve into the causes for these restrictions & explore a way to trade far OTM options.
Understanding far OTM options:
Far OTM options have strike prices that are significantly different from the current market price.
These options are more risky but less expensive than options that are closer to the market price.
Far OTM options are important for both hedging and speculation.
They offer potential for making profits due to their significant profit potential.
Why far OTM options are important?
Affordable Protection: OTM options cost less than ATM or ITM options for hedging portfolios.
Increased Gains: OTM options boost your gains from small price changes in the asset you're trading.
Limited Losses: Maximum loss equals option cost, protecting against unlimited losses.
More Options: More strike price options for tailored risk hedging.
Advantage of Time Decay: OTM options decay faster, reducing hedge costs.
However, it's important to consider the drawbacks of using OTM options:
Low Probability of Expiring ITM: Far OTM options aren't effective hedges if market moves against.
Emotional Impact: Get ready for OTM option losses, handle risks.
Expertise: Advanced OTM Option Understanding. Not for Novices.
Select a trustworthy broker who offers a wide range of options for other people's money (OPM) and has great support for managing risks, even in difficult situations or technical issues.
Why buying far OTM options are blocked in India?
Only a few brokers in India allow trading in far OTM options due to a few important reasons.
Regulatory Restrictions: One of the main reasons why far OTMs are blocked is regulatory restrictions.
Open Interest (OI) Restrictions: SEBI imposes limits on the total outstanding positions (Open Interest) for each option contract across all brokers, limiting larger brokers' ability to offer a wide range of out-of-the-money (OTM) options.
Risk Management Concerns: Brokers face more risk and potential damage to their reputation when they help trade far Out-of-The-Money (OTM) options. These options have a low chance of ending up profitable. Regulators want to protect investors from excessive risk and potential losses, so they limit trading in these options.
Investor Protection: Limiting far out-of-the-money options makes sure new traders don't take on too much risk they don't fully grasp. Regulators such as SEBI strive to safeguard investors and hinder them from causing market instability.
Liquidity Concerns: Far OTM options typically have low trading volumes and limited liquidity, leading to increased slippage and higher trading costs. Regulatory restrictions ensure that options with sufficient liquidity are available for trading, enhancing market efficiency.
Market Dynamics:
Limited Demand: The demand for out-of-the-money (OTM) options in India is relatively low, as retail investors tend to prefer lower risk strategies.
Market Stability: Regulators in India want to keep the market stable and prevent too much speculation by placing limitations on far-out-of-the-money options.
Discount Trading: Indian brokers highlight low-cost commissions and discounted trading models, which may not be suitable for focusing on out-of-the-money (OTM) options.
Technological and Resource Constraints:
Infrastructure Requirements: Smaller brokers may not have the resources to handle diverse OTM options effectively.
Compliance Costs: SEBI regulations and risk management for OTM options are costly, particularly for smaller & high volume firms.
Competition and Alternative Focus:
Competitive Landscape: The Indian brokerage landscape is highly competitive, with new players constantly entering the market.
However, it's important to note that the situation is evolving:
Growing Demand: As the Indian market matures and experienced traders increase, the demand for OTM options is gradually rising. Some good brokers are acknowledging this trend and offering dedicated platforms with better risk management benefiting advanced traders.
Technological Advancements: Technological advancements may make it easier and more cost-effective for some brokers to offer a wider range of OTM options unlike many others.
Which Brokers Allow Far OTM Options in India?
Though buying far out-of-the-money (OTM) options in India is limited, some brokers allow options contracts that are far from the current market price, satisfying today's traders' needs.
One such renowned broker is IIFL Securities.
They also provide Margin Trading and Buy Now Pay Later (BNPL) options to help traders execute their ideas better.
Example of allowed far OTM options:
Here's an example of the percentage that can be allowed for deep out-of-the-money (OTM) options.
Buy Options :
Index: You can buy OTM Options within 20% of LTP.
Stock: OTM options can be bought up to 20% above LTP.
Let's make things simpler. If the Nifty Index is at 22000 and we have a 20% range, it means we can increase or decrease by 4400 points.
So, for any option expiry, choose a strike price between 17600 and 26400.
Sell Options:
Index: When you sell out-of-the-money options for indices, there is no specific limit on the strike price.
Stock: But, there is a 30% limit for selling Out-of-the-Money stock options.
Remember:
Deep out of the money (OTM) options may have low trading volumes, making them illiquid.
When trading deep OTM options, it is recommended to use Limit Orders instead of Market Orders.
Market Orders may be restricted for stock options due to the low trading volumes.
Choose best broker for depends on your needs, risk tolerance, and trading style.
Use brokers like IIFL Securities & enjoy executing far OTM options today as part of your strategies.