All sorts of trading in momentum investing are risky. Call-and-put options trading is, therefore, not devoid of risks. In the arena of trading, the call option lets the buyer buy an asset at a particular price and wait for a profit when the asset price rises thereafter. whereas put options allow the buyer to sell their assets at a particular date at a profitable price.
Though it sounds simple, option contracts can be risky if you cannot time your investments according to bullish and bearish trends. Trading in call-and-put options involves some degree of risk. Knowing them thoroughly will help you dodge the risks properly.
Though it sounds simple, option contracts can be risky if you cannot time your investments according to bullish and bearish trends. Trading in call-and-put options involves some degree of risk. Knowing them thoroughly will help you dodge the risks properly.
The Risks Associated With Trading Call and Put Options
Many traders rely on technical analysis and market indicators, such as the put-call ratio, to predict market movements. This helps them predict risk in a timely manner and secure their money. In option trading, long call options pose the least risk compared to naked call options.
Only continuous monitoring of the trends through robust algo trading software will help you sense the risks of call and put option trading on time. But before striking into real practice, know the most common risks associated with trading in call and put options below;
Only continuous monitoring of the trends through robust algo trading software will help you sense the risks of call and put option trading on time. But before striking into real practice, know the most common risks associated with trading in call and put options below;
1: Market Risk
Market risk is one of the most prominent and obvious risks you may face while dealing with call and put option market trading. The reasons that may cause the market risks include;
- Adverse movements or unexpected fluctuations in the pricing of the underlying asset.
- In call option trading if the asset price does not rise according to the expectations of the buyer, then the option may expire worthless for them
- On the other hand, in the case of put options, if the asset price does not decline, then it will result in a complete loss of the invested premium
- Market volatility directly causes market risks due to untimely price swings, which makes it challenging for investors to predict stop-loss orders.
Thus, to minimize market risks in call and put option trading, traders need to continuously monitor market conditions using advanced algorithm trading software.
2: Time Decay Risk
The time decay risk is another glaring risk that traders may face while conducting call-and-put option trading. Analysis of 30-day and 60-day contracts revealed that in-the-money and out-the-money contracts have a slow rate of time decay throughout the contract life. However, the risk concentrates on the final day of the option trading. The reasons that may cause a Theta or time decay risk include;
- As the expiration date of an option approaches, its time value starts decreasing. This time decay accelerates as the option approaches expiration.
- In such a condition even if the market moves in your favour, the decreasing time value will erode your chances of securing a favourable output
Time decay can equally affect call and put option trading. Therefore, traders need to contemplate more profoundly the timing of their trading by using the Options Strategy Builder. It will help them enter and exit a trade in a timely manner by minding the inevitable loss of time value.
3: Leverage Risk
In momentum investing, leverage is the most compelling aspect for the traders. It allows them to control a significant market position with a relatively low capital investment. However, volatile market conditions can influence considerable leverage risks, leading you to unwanted capital losses. To minimize the leverage risks in option trading you will have to;
- Practice utmost discipline and sincerity while investing and selling your assets.
- Following the trends and market sentiments using the put call ratio.
- Setting stop-loss orders to exit from high-risk trades timely.
- Limiting your position sizes according to the changing market dynamics.
4: Liquidity Risk
Liquidity risk means when you cannot buy or sell your desirable assets at a fair price at a desirable time frame. In less liquid markets, traders may struggle to execute trades at their desired prices, which can lead to slippage. This risk particularly heightens when the trading volume is low, causing it difficult to find a buyer or seller to trade the asset. Other conditions that may increase your liquidity risk are;
- Biding in less popular assets in the market.
- Trading when the market is less volatile for the underlying assets.
- The bid-ask spread is wide, which leads to higher trading costs and slippage, making it difficult for traders to exit from a high-risk investment.
- Assets with low liquidity can impact your exit decisions in the future.
Therefore, to mitigate the liquidity risk from call and put option trading, you need to always check the liquidity of the assets you are considering dealing with.
5: Interest Rate Risk
For long-term investments, you need to consider the interest rate risks. If you are thinking about opting for long-term option trading, then know the following aspects of interest rate risks;
- Changes in the interest rates can directly impact the cost of your underlying assets.
- These changes in pricing will then impact your option’s pricing while selling them.
- A rising interest rate will increase the cost of buying an asset during call options and decrease its cost in the put option.
- In contrast, the decreasing interest rates, though rare, can act inversely.
Therefore, investors need to be well aware of the economic environment to reduce the risks of high interest rates. They need to contemplate global political events that may directly or indirectly change the interest rates of their assets. Monitoring economic indicators and central bank policies can help them too in reducing this risk.
6: Platform And Execution Risk
As trading is now getting more and more digitalised, considering the platform and execution risk is equally important for the traders of today. The risks that may fall under this category include;
- A technical issue in the digital platform you are using for call and put option trading.
- This may result in a delay in order execution, system outages and data feed errors.
- This can cause you losses as you will not be able to execute your trading decisions at a desirable time at a desirable price rate.
Therefore, considering your algo trading software or platform for option trading, consider its reliability and previous performance.
7: Assignment Risk
In both a call option and a put option the investor needs to fulfil the contract. The assignment risk often occurs during the filling of this contract during the buying and selling of assets. Things you need to consider about assignment risk are;
- Assignment risk can occur at any point before the expiration of the investment, particularly if the option is in-the-money.
- This risk can make you face unexpected financial and legal obligations.
Therefore, to mitigate this risk, the option trader must prepare themselves for any possible assignment risk with a clear management plan. They must ensure sufficient capital to meet their obligations on time.
8: Volatility Risk
Volatility though desirable for trading, can be a daunting risk too. Let’s understand this risk through these pointers;
- High volatility offers you opportunities to move your assets with timely navigation. But due to its unpredictability, this navigation often becomes challenging
- The implied volatility that shows the chances of future volatility can directly manipulate the pricing of your assets
- Decreasing volatility can erode your premium whereas a sudden spike can cause rapid changes in your option’s values
Therefore, sudden changes in volatility can directly impact the value of your call-and-pull option trading strategy. You need to monitor volatility levels closely to understand how they can influence your trading decisions.
9: Strategy Risk
A strategic misinterpretation can gravely impact your trading success. The planning that you take to reduce strategy risks will be;
- You will have to devise strategies for each aspect of option trading, including volatility changes, market movements, and time decay.
- These strategies need to be multidimensional and well-contemplated for effective execution.
- You need to have a complete understanding of the benefits and consequences of your complex trading strategies.
For effective curation and execution of trading strategies, you must educate yourself with up-to-date market strategies.
To conclude, there are several risks associated with the call-and-put option trading. Understanding the risks and Mistakes to Avoid in Put and Call trading will help you to leverage your investments in the marketplace better.
By timely analysing the market volatility risks and time decay risks you can optimise your performance in the complex trading arena. In this matter, SpeedBot, being one of the best algo trading software, can be your ideal companion to guide your trading routes.
By timely analysing the market volatility risks and time decay risks you can optimise your performance in the complex trading arena. In this matter, SpeedBot, being one of the best algo trading software, can be your ideal companion to guide your trading routes.