Many traders trade in option segment. In option segment, trader has less risk and can earn maximum profit. Traders have to invest fewer amounts and can earn maximum profit some times. Suppose trader has invested only 2000 rupees, he or she can earn unlimited profit, but at the same time, here risk is of only 2000 rupees.
I can show you one method that can help you traders to minimize your risk during trading in option segment. Trader can follow some simple steps to apply this method.
First of all trader have to find intrinsic value for particular stock. We can find intrinsic value by subtracting strike price from current price.
Intrinsic value = Current LTP – Strike Price.
Now trader has to calculate interest rate of current LTP using following formula.
Interest Rate = (Current LTP *X/N) %
Here, X is difference of days between current date and expiry date.
For e.g. if current date is 5/5/2014 and you expiry date is 29/5/2014 (dd/mm/yyyy) then you difference will be X= (29-5) = 24.
Here, N is total days of current month as well as moth of expiry date. Suppose your current date is 5/5/2014 and you expiry date is 29/5/2014 (dd/mm/yyyy) then your N will be 31 days.
Because you current moth and expiry month both are same and total days in that month are 31. So your total numbers of days (N) are 31.
Generally trader can calculate interest rate at 3%. If trader is trading in indices then he or she can use 5% of interest rate.
Once trader get the intrinsic value then trader have to calculate actual premium price for scrip. For that check if the intrinsic price is greater than zero or less than zero. If intrinsic value is greater than zero then sum up that intrinsic value with interest rate.
And if the intrinsic value is less than zero (negative) then use zero as intrinsic value and sum up that zero with interest rate. This is how trader can find actual premium price for particular scrip.
Keep in mind if actual premium price is greater than given premium price then you are trading at risk. Means trader is paying higher premium value and if some how he or she makes loss he or she will lose more money.
And if actual premium price is less than given premium price then trader is trading with less risk. Because trader is investing with less premium value and that’s why if he or she is makes any kind of loss he or she will lose less amount. And this is how trader can find out risk during trading in option segment.