How to minimize risk during trading in option?

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.

Trend line in technical analysis

Trend line can be drawn between two or more price pivot points on charts. In technical analysis trend line is used to find entry and exit point when trading. Trend line is a straight line and used to confirm trend in stock market. Many people call trend line as Dutch line because it was first used in Holland.

Trend line can be like boundary for price movements. Most charting software draw trend line automatically while some charting software enables traders to draw their own trend line.

Six types of trend lines are available.

• ·         Linear Trend line
• ·         Logarithmic Trend line
• ·         Polynomial Trend line
• ·         Power Trend line
• ·         Exponential Trend line
• ·         Moving average Trend line

• Linear Trend line:

Linear trend line can be used if the price data are increasing or decreasing at steady rates. If the plotted price points follow the straight or nearly equal to straight line then you can call it as linear trend line.

 Formula:

                                                Y =m*x +b

Here m = slope (x, y) while b represent the price point.

• Logarithmic Trend Line:

Logarithmic trend line can be used when the rate of changes in price increases or decreases quickly. If the plotted prices increases or decreases quickly and then level out you can use logarithmic trend line.

Formula:

y = (c * LN(x)) + b

c: =INDEX(LINEST(y, LN(x)),1)

b: =INDEX(LINEST(y, LN(x)),1,2)

• Polynomial Trend line:

Polynomial trend line can be used when data fluctuate many times. It is useful for analyzing profit loss over large data.

Formula:

2nd Order Polynomial Trend line

y = (c2 * x^2) + (c1 * x ^1) + b

c2: =INDEX (LINEST(y, x^ {1, 2}), 1)

C1: =INDEX (LINEST(y, x^ {1, 2}), 1, 2)

b = =INDEX (LINEST(y, x^ {1, 2}), 1, 3)

3rd Order Polynomial Trend line

Equation: y = (c3 * x^3) + (c2 * x^2) + (c1 * x^1) + b

c3: =INDEX (LINEST(y, x^ {1, 2, 3}), 1)     

c2: =INDEX (LINEST(y, x^ {1, 2, 3}), 1, 2)

C1: =INDEX (LINEST(y, x^ {1, 2, 3}), 1, 3)

b: =INDEX(LINEST(y, x^{1, 2, 3}), 1, 4)

• Power Trend Line: 

When the price rate increases at specific rate at regular interval, we can use power trend line.

Formula:

y=c*x^ b

c: =EXP(INDEX (LINEST(LN(y), LN(x),,),1, 2))

b: =INDEX (LINEST(LN(y), LN(x),,), 1)

• Exponential Trend Line:

Exponential trend line and power trend lines are similar in shape. Difference between these two is power trend line gets symmetric arc while exponential trend line takes sharp arc at one end. Direction of exponential trend line may be either up or down. You can use exponential tend line when price value increase or decrease rates are constantly increasing.  

Formula:

y = c *e ^ (b * x)

c: =EXP (INDEX (LINEST(LN(y), x), 1, 2))

b: =INDEX (LINEST(LN(y), x), 1)

• Moving Average Trend line:

If the price value fluctuate uneven (up down) we can use moving average trend line. Moving average takes average of specified number of points and uses that average as next point.

Morning Star - Candle stick pattern.

Morning star is a candle stick chart pattern. Morning star pattern is used by technical analyst of stock market to find reversal of trend in stock market. Technical analyst use morning star patterns to predict future prices of stocks. Morning star pattern occur at the end of downtrend and indicates the change of trend from bear to bull trend.

Morning star pattern is made up of three candles. First one is large bearish candle, second or middle candle may be bullish or bearish or neutral. Second candle may be small in size. Third candle large bullish candle. 

On the first day of morning star pattern supply dominate the demand and creates large bearish candle. On second day candle opens with gap down. Bearish or bullish gap down will decrease the price of scrip. The candle stick on day two is small and can be bullish, bearish or neutral.  On the third day of morning star large bullish candle indicates increase of demand. Third day candle pull the price upward and eliminate the loss on first day candle.

Morning star consists of three candle sticks. Trader will use higher volume to confirm morning star pattern on third day. Trader or market analysts usually see length of candles to figure out strength of pattern.

 In order to have valid morning star most traders will look at the top of the third candle to be at least half way up the body of first candle.  If first and third day candles are larger and if the third day candle moves higher in relation with first day candle then it is strong sign of reversal in trend.