The Multi Commodity Exchange (MCX) of India has cautioned investors against the high risks involved with options trading, and urged that those with limited knowledge should exercise caution and refrain from such trading activities, as they could otherwise face huge losses.
The MCX recently came out with a circular in this regard on July 11, titled Precautions for clients dealing in Options. The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) and other exchanges have also come out with similar circulars.
Vinit Khandare, CEO and founder, MyFundBazaar, a mutual fund investing app, too, shared his experience of earlier days when there were no smartphones and how investors would spend hours scrolling through a company’s annual reports and other business statements, and then invest after doing a thorough research.
But now, “more and more people are turning to social networks. Owing to the lack of credibility in these social networks, investors still opt to trade, because of the mindset that losses are fairly limited in options. However, an investor needs to understand how options are priced, along with the factors that affect them, including implied volatility,” says Khandare.
Incidentally, the BSE has also pointed out on the dangers of trading in options on the ‘guidance’ of such influencers,without having the required knowledge on the subject.
“It has been observed that certain members are availing the services of influencers to promote “Options” trading, thereby inducing the clients to trade in ‘Options’ without considering the product suitability/knowledge and trading experience of the clients,” read a para of the circular by the BSE.
Says Atanuu Agarrwal, co-founder, Upside AI, an artificial intelligence powered portfolio management service (PMS): “Not everyone can competently analyse different types of assets or industries or stocks. Additionally, to gain competence, one requires in-depth research and study. Unless one is a genius with an eidetic memory, this usually takes years of theoretical and practical experience. It is safe to say that most social media influencers don’t meet this criterion.”
What The Exchanges Said?
The exchanges came out with a guidelines about options trading and how one should proceed with trading in them.
Option Trading Tips: There are many Telegram and other social media groups where thousands of users interact and circulate option trading tips among themselves. Exchanges have warned that these trading tips are not at all trustworthy,and investors could incur losses from such advice.
Khandare says that this new trend of using social platforms, such as WhatsApp, Telegram and other online forums to share investment decisions, which is known as “Social Investing”, is lately on the rise.
“But investors should know that most of them lack credibility. An option premium is based on the likelihood that the underlying asset will finish ‘in-the-money’ or with some ‘intrinsic value’ (and not because someone somewhere said so online),” he says.
“Several factors come into play that affect the probability of this outcome. With more time to expiration, the chances of a profitable expiration increase, along with the price of the options. Conversely, if the option loses intrinsic value or goes further out of the money, the premium falls,” he adds.
Options Trading Requires Knowledge: The exchanges have urged market participants to educate investors about knowledge required for options trading.
Palka Arora Chopra, senior vice president, Mastertrust, a capital markets company, explained that there are various knowledge (Option Greeks, others) and skills (understanding of option fundamentals), which a retail investor must possess before jumping into options trading.
She explained with an example.
“Suppose, you are a new trader and you take a long position in an index option, but then that index is not moving in your preferred direction as fast as your expectations, and then the option expiry time comes, and it expires. Hence, time is an important factor in options trading, since the option premium always factors in the time decay value of money, among other factors.”
Writing/Selling Option: The exchange circular further mentioned that writing or selling options without adequate knowledge is not advisable. SP Toshniwal, founder and CEO, ProStocks, a stock broking and financial services company says that retail investors should never try to write or sell options, unless they have expertise in this domain.
“This is because when you sell options, then you are restricting your gains, but maximising your losses, since there is no upper circuit on an option premium. The option premium can touch Rs 1,000 as well as Rs 100 on the same day, depending on other factors.”
Trade Tips From Finance Influencers: There are many so-called financial influencers with millions of followers, but most of them are not Sebi-registered investment advisors. The exchanges have now cautioned investors from taking advice from such influencers and non-registered investment advisors,as such advice may not hold true in the market, and also because their credibility is in question.
Says Abhijit Shukla, CEO and director, Tarality, an alternative asset investment firm: “Nobody can guarantee that a particular option’s premium will go up or down. Millennials and others who are investing in options should be very careful and must do in-depth research before investing.”
“While options trading is one of the best ways to benefit from fluctuating stock prices, since there is no concrete guarantee whether the stock prices will increase or decrease in the near future, investing in options for millennials for a quick profitcan become significantly risky, owing to its time-sensitive nature,” Shukla adds.
Leveraged Products Like Options: Options are, by default,an inherently leveraged product, and investors should understand this before trading in them. Chopra explained that the option premium we pay is very small when compared to the amount of exposure we are getting in the underlying stockor index.
He said that just like “there are two sides of the coin, similarly leverage also has certain downside implications and upside implications (Leverage can be made very useful and powerful when it comes to investing, as it can turn relatively small amounts of capital into significant profits).So, one must be very careful, as options can have higher risks in comparison to stocks, and unlimited loss potential.”
Sharing of Trade Password: The exchange circular cautioned investors against sharing their trade ID and password with others. Some users share their ID and password with their friends and others, and they trade as a proxy on their account. Exchanges cautioned against using such a practice.
“Trading members are also advised to regularly caution and create awareness among their clients/investors about sharing of trading credentials – login id and passwords, including OTPs,” read a circular from MCX.