Retail, wealthy traders turn to riskier options writing
Shift comes amid higher retail participation in derivatives
Retail and wealthy individuals are gravitating towards writing options contracts — the more riskier side of the options market and once the preserve of large institutions or expert traders.
The shift to options writing comes amid regulatory concerns on increasing retail participation in the derivatives segment, where the odds are overwhelmingly stacked against them.
RISKY BET
Options trading gained momentum in the aftermath of the pandemic. Until now, most individuals focussed on options buying, given the lower risks as losses are limited to the premium paid, which could be a few hundred or thousand rupees. Options writers face unlimited risk and need to pay high margins, amounting to ₹1-2 lakh per trade.
“There has been a 20-30 per cent uptick in the number of wealthy and retail individuals who have taken to options writing in the past six months or so,”
OPTION WRITERS: THE WINNING SCRIPT
Traders who write an option receive a fee or premium in exchange for giving the option buyer the right to buy or sell shares at a specific price and date
Theta measures the time decay or erosion of an option's value as time passes
Options writers can keep the premium if the option expires worthless
Index options premium turnover at the NSE stood at ₹138 lakh crore for FY24, a record said Soni Patnaik, AVP - Derivative Research, JM Financial Services.
DECLINE IN VOLATILITY
The advent of daily and weekly expiry has increased the probability of making money for options writers. Market volatility has reduced considerably over the past three years, which is why options writers have not had many episodes where they have lost significant money.
“We haven’t seen large corrections of 10-15 per cent during this period. The low intramonth volatility has significantly increased the chances for options writers to make money,” said Devarsh Vakil, Deputy Head - Retail Research, HDFC Securities..
Options writers have been benefiting from theta decay, the amount by which an option’s value declines daily, said Chandan Taparia, derivatives analyst at Motilal Oswal Financial Services.
During the last expiry day, for instance, a number of retailers tried to capture a small premium of ₹10-15 by selling naked put options and call options. They gain the entire premium if the market stays within the options strike price range. If there’s a breach on either side, the risk of losing money increases significantly.
“It is imperative to hedge any naked options writing positions and convert them into options strategies such as spreads, which are becoming popular among participants nowadays,” said Patnaik.
STRATEGIES ADOPTED
Options writing strategies vary. An investor with an underlying stock could use covered calls to increase his or her income on the holding. Others could use put selling to get into a new stock which they don’t own, and there could be traders who may want to use theta decay to benefit out of options writing.
As more individuals take to options writing, they may find themselves on one side of the trade, raising risks exponentially. “A major surprise or large market movement could result in options writers losing their shirts,” said Vakil.