Covered call is very popular among the high net worth individuals who buy shares for the long term. These people take benefit of covered call to make money every month. Covered calls are very poplar in US where high net traders are many.

What Is Covered Call

Covered Call is a method to sell shares in a future date with no obligation to buy back if certain conditions are not met.

When you own a stock you have the right to sell anytime at market price or in future at a higher price using options. Covered call is selling the stock to someone else at a higher price in a future date for an agreed money as shown in in system. This money varies from stock to stock and price to price.

Basically when a covered call is done the owner of the stock sells the stock to someone else at a agreed price to get cash today. This is done at a higher price than the current price of the stock. This means that the owner of the stock gives the buyer of the option the right to buy his shares before the option expires, at a predetermined price, called the strike price.

Now What May Happen In Expiry

If the stock does not reach the predetermined price or the strike price which the owner sold the stock for, the Call Option expires worthless and the owner of the stock keeps the money he got to sell the stock at date price.

If the stock reaches the predetermined price or the strike price which the owner sold the stock for, the Call Option becomes In The Money (ITM). In this case since the sell price is lower than the buy price the owner have to take the loss on the option sold, but can cover the loss by selling the shares he owned.

Most of the times the sold options expire worthless so the owner of the stock keeps the money he got while selling the call. Otherwise they can always sell the stock to cover the loss.

This week I finished reading a book written by Robert G. Hagstrom about Warren Buffett – the best investor in world entitled “The Warren Buffett Portfolio.”.

This book is different than what I have read on Warren Buffett in other books.

Here I would like to point out some very important highlights of the book.

Stock Is a Business

Before you buy a stock you must think whether you want to be a part owner of that business? If you are not comfortable being its owner then do not buy that stock.

Think Long Term

If you want to start a business, do you want to keep making money for the short term or long term? Of course you will plan for the long term. Same should be the case if you want to buy a stock for investing not trading.

Note that stock investing is not the same as stock trading.

Stock trading is buy and selling a stock for intraday, few days or few months. Stock investment is holding a stock for at least about a year. Though Warren Buffett average holding period is more than 5 years.

Increase Your Investment Size and Do Not Diversify

Warren Buffett did not believe in too much diversification neither keeping all eggs in one basket. He did thorough research and invest a lot of money in a stock for a long timeframe. Warren Buffett did not invest in mutual funds also as he was against too much diversification. His exact number of stock holding is unknown.
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However if you are not as good investors as Warren Buffett, it is advisable to invest in mutual funds.

Reduce Turnover

Warren Buffett believed not to churn in and out of stocks frequently to avoid paying taxes on gains made. In India long term capital gains are not taxed. For that one needs to hold the stock for at least one year. Warren Buffett that taxes will reduce the profits coming out of the stock investments.

In India long term profits are not taxed because the company has already paid their taxes. The profits you get after selling the stocks after one year is after paying the taxes by the owners of the company. Since the taxes has already paid there is no need to pay taxes again. However short term profits (less than one year holding) are taxed.

Ignore What Experts Say

Warren Buffett rarely listened to experts forecast on future of a stock price long or short term. He focussed on fundamentals of a company. If believed that if a company is good at fundamentals the stocks will price in that in future.

Traders trading Intraday should know where to take a stop loss. This article discusses some stop loss methods that you can follow.

Points / Cash Stop Loss Method:

This is the most common method that most Intraday traders use. Basically it is the amount one trader is willing to lose. Let say his total margin blocked is 1 lakh, and he is targeting 2%. This is 2000 profit a day. In that case his stop loss can be anywhere between 1000 or 2000 not more. This way if the trader is successful in 60% of the trades he makes money. This cash can be converted to points also. For example if 1 point is Rs. 2000, then profit can be 1 point and loss can be 0.5 to 1 point.

Average True Range (ATR) Stop Loss Method

Read my post on Average True Range (ATR). It goes into details of the ATR method calculation and how to use it for taking a stop loss.

Day High And Low Stop Loss Method

This is strictly for Intraday traders only. They can take a stop loss if the stock breaches the days low. For this the ideal time to start the trade is at 10 to 11 am so that the days low is clear. For positional trading last 30 days low is a good way to keep the stop loss. However if the last 30 day is way to low and you are not comfortable losing that much money then the Points / Cash Stop Loss Method is a better way to take a stop loss.

Software Indicator Stop Loss Method

This is advanced way to decide a stop loss. This is used by professionals with technical knowledge. These indicators can be moving averages, RSI indicators, stochastics, rate of change, trailing stop method (keep increasing the profits stops as the stock move up and keep booking profits in certain percentage of holdings until all is sold), etc.

Note that trailing stop method can be done for both booking profits and taking a stop loss.

For example a trader buys a stock at 100 and keeps 50% sell as stop loss at 99, if hit he brings the nest stop for rest at 98 – then there is a possibility that stocks bounces back and the trader ends up in profit.

As you can see the trailing stop method to take out profits or losses needs a lot of patience and is possible on big trade positions only.

Recommended Reading:

Average True Range ATR Stop Loss Method

Where Should You Take A Stop Loss In Stock Trading

Percentage On Margin Blocked Stop Loss Method

Second Stop Will Ask For Extra Margin

Learn why averaging out options does not make sense – it is a pitfall of losses.

In one word if I have to answer that if averaging out options makes sense. The answer is

NO

Why? Because when you buy options you are racing against time. This time can be few months, or few days or even few hours.

The option you are averaging has to be above average for you to profit – for that it has to take a “U” turn.

Assuming Nifty ran from 8000 to 10000 levels like it did from Jan 2017 to July 2017 and a trader thought it will run more and bought 10100 Call Option at 100. Now Nifty fell at 9900, the trader bought few more lots at 75 premium of the same strike. Nifty falls more, on hope that it will reverse, the trader buys more at 40, and “averages” the option at 50. The option is right now at 40.

Next day Nifty does not move, India VIX drops and option price drops to 35. The trader gets nervous.

He starts praying to the almighty forgetting that he did the mistake, not almighty.

Nifty starts to recover, but time remaining is 1 day. Nifty is still 200 points far from the 10100 strike.

What are the chances of 250+ points move in next 2 days? Less than 1%.

This is life of an option buyer trading on hope.

Please refer this article – option trading is science or art. I had said both option traders trading on Greeks and hope lose money.

The above article is inspired by a real trader who called me yesterday and told his story sobbing.

This is what he did this month itself, August 2017 – please do not attempt this:

Buy OTM (Out of Money )10500 CE, then buy more to average it out
Buy OTM (Out of Money 10100 CE, then buy more to average it out
Losing a lot of money mid-August, so in frustration:
Buy ITM (In The Money) 9500 CE (ITM options are VERY COSTLY – NEVER BUY ITM OPTIONS), then buy more to average it out.

Now tomorrow – 31-Aug-2017 is expiry. All his OTM options will expire worthless. Means his money to buy these options will become ZERO.

Not sure what will happen to ITM option of 9500 CE since he did not tell the price at which he bought, but I am sure losses here will be more than the OTM options he bought.

At last he did the course and his financial destruction will stop.

Let me warn you. If you are trading in hope or speculation – and /or you are averaging out options to make money – YOU WILL LOSE MONEY AND IT CAN BE UNLIMITED MONEY.

Traders who are firm believers of Technical Analysis and try to trade Greeks of Options, they feel option trading is a science. They try to derive a formula so that they come out winners every time.

Traders who trade on hope think option trading is an art. They “Feel and Trade”.

As it is obvious they both lose money.

No one can predict what is the future option Greek for a given option. Neither can anyone predict what premium the option will have in 2-3 days time. This is the reason most option traders who trade on hope or who trade trying to manage Greeks lose money.

One of the biggest losers are the Delta Hedging traders. This sounds so technical that traders get attracted to it.

In US Delta Hedging is automated. It is done my software perfect to manage Delta of options. The trades are so fast that humans will not be able to manage it. Within milliseconds an option is bought and sold which is impossible to be done by humans.

On top of that the automated system keeps a check on Delta of every option strike of that stock or Indices. As soon as the Delta is breached, it gets out of one position and gets into another in less than half a second.

However these are done by high net worth individuals or finance institutions. It takes millions to make a automated system to trade.

Since it is out of reach for retail traders they should trade with a proper plan, else there can be losses and it may continue for years.

Trading on hope is self-explanatory. Another great way to lose money trading the stock markets.

So who makes money? Trades who trade with a plan. Without planning you cannot manage your finances so how can you win trading options?

Want to learn how to trade with a plan? You can do my make monthly income from options course. Traders who have done it are doing well today. They were losers before doing my course. For any questions contact me.

Trailing stop loss is a great way to increase your trading profits. Not many traders use trailing stop loss to increase their profits.

Today many online brokers have platforms where traders can use trailing stop loss and increase their profits.

Trailing stop loss is also used by experienced Intraday traders.

Stop loss is different that trailing stop loss.

For wealthy traders trailing stop loss is a boon.

What is trailing stop loss?

Trailing Stop Loss is a taking profits off like a ladder.

Some profits on the first ladder, then some off next, then some more on the next and all in the fourth or fifth ladder.

Example of A Trailing Stop Loss to Take Out More Profits

Trader A buys 100 stocks of company XYZ at 500. His target is 550 or above. Stock moves to 545. He sees it and keeps a sell order of 50 stocks (50%) at 550. Stock moves up and reaches 550. 50 of his stocks gets sold at 550. He keeps a stop sell order for the rest of the stocks at 540. Stock moves up to 565. Seeing this the trader moves his stop sell order for the rest from 540 to 560. Stock goes to 570. The trader moves the stop sell to 565. Stock now moves to 578. The trader moves the stop sell to 575. Stock comes back bit down and the stop sell order at 575 gets hit. All stock gets sold.

Here is the calculation: Stock sold at (550 + 575) / 2 = 562.50

So a stock that was supposed to be sold at 550 got sold at 562.50.

The trader made extra money because he followed the trailing stop loss method.

Trailing stop loss is a great method to make more profits from a profitable trade.

Is it possible in futures and options trading?

Yes it is possible. However more skills and experience is required.

Is this possible while taking a loss?

Ideally loss should be fixed and taken immediately. However one can try to take 50% loss at a certain stage then wait for a pullback then take a profit or get out cost to cost in the remaining. But if pullback does not happen then the trader should exit at a certain point all of their holdings.

It is always better to take a loss at a predefined place but keep a trailing stop loss (actually profit) in ladder fashion written above.

Is it Possible To Automate Trailing Stop Loss to Take Out More Profits?

Yes institutional investors and fund houses especially in USA have automated many trading strategies including trailing stop loss orders to decrease loss and increase profits. However the software to automate trades are very costly. A multi million dollar fund house can afford such machines and software, but for retail traders the only way out to get more profits out of trailing stop loss is to do it manually.

Hope you learned a valuable lesson today. More will keep coming.

Happy Trading.

Here is one email I got from a novice trader:

Mr. Dilip, I am totally novice into options and while talking to good reputed stock brokers, assessing my risk capacity and capital investment (max 30k), they have informed me to do in derivatives (options) trading, where you pay minimum margin and also will get time to put in your stop-loss gap and other triggers, where you can earn minimum profit of Rs.5,000/- pm or more.

Next, in the cash or equity segment, you have to pay entire margin money and the sale value after brokerage and other taxes parentage will be far less than options trading.

But to me all these terms are very new and not able to practically do the things.

So, persons like me who are very conservative, middle aged and income generation is more priority, what will be your suggestions.

Read the first paragraph carefully. Traditional brokers who have a target to achieve making money from brokerages will tell anything to their clients so that they generate a brokerage.

One of the best ways to make money from brokerage is to sell a dream like in options you can invest 5k and make 10k.

Well technically its true but not many are able to live that kind of dream every day.

Invest 5 and make 10 is 100% return. A new comer will dream something else when he listens to this. He will dream like – invest 10 lakhs and make 20 lakhs (this may be his savings), or invest 20 make 40, now invest that 40 and make 80…the dream goes on and on.

What happens next? The poor trader immediately agrees to their brokers advice and ask them to buy the trade they recommend. Brokerage made. Target Next customer.

Why brokers never suggest Futures? Because 50% of their clients do not have the margin required to trade Futures. What is the point in selling a dream to someone who does not have the cash to buy that dream?

Note: Future trading requires more money as margin than Options buy trading. Option selling requires same margin as Future buy/sell, so options selling is never sold to the clients.

Money getting double is a great dream to sell and it will continue.

Now the real answer:

1. Stock trading is a business and risk is involved.

2. Option buy and sell can double your money but the chances are less than 1%, as either the trader exists at 2-5% profit or takes a stop loss at 50% or let the option expire worthless (all money gone down the drain).

3. Option buyers must always hedge their positions but that still does not guarantee profits. Naked option buying a very risky. Unfortunately this is the most sought after trade by option traders because option buying is very cheap and comes with limited loss.

4. Yes you get more leverage with less money in options, but you should know that it has an expiry time and you should be correct in your trade before the expiry comes.

5. See point no 1. Stock trading is a business but what business you can start with 30K? Even if you make a return of 10% on 30k that is just 3000. What difference does that make?

Change your mindset of investing less and making more. Options are a great tool if you learn to trade them properly.

Arbitrage is done my big financial institutions. It is simultaneous selling and buying of two similar financial products to take benefit of difference in prices.

Though arbitrage is no more popular now, it was very popular a few years ago. Trading volumes were less so arbitrageurs took a lot of benefit. However now trading volumes have increased and there are a lot of systems that make sure there is not too much volatility in markets.

But still arbitrageurs exist.

Some traders use automated trading systems to arbitrage.

One Simple Arbitrage example – This is called Pairs Trading

A trader can buy one stock and at the same time sell one stock from the same business sector. If one side move comes more in that sector the arbitrageur can make money. However this is very risky due to the nature of stock markets.

Earlier it was not that hard because stocks of the same business sector used to move in same direction, however now stocks at company dependent not sector specific dependent.

One Example of Risky Arbitrage

Acquisition of one company of another company is very common. This news is open to all and is known sometimes 30 days before the actual acquisition actually takes place. Suppose news has come that company A will acquire company B, then arbitrageurs will buy stocks of company B and sell stock of company A. This is very risky arbitrage strategy but there are people who try it.

Selling in One Exchange and Buying in Another

This can be done my institutional investors only who have the right to sell or buy the same stock at different exchanges.

Suppose a company stock is listed in New York Stock Exchange (NYSE) and also in London Stock Exchange (LSE). Now because of different demand and supply, prices can be different in different markets. Let say company A is 45 in NYSE but 46 in LSE then an arbitrageur will sell in one stock market and buy same number of shares in another. After sometime one will give profit.

But they need to enter large positions to make huge gains.

Please note that earlier not many traders had the software or technology to know these arbitrage opportunities but in this modern world there are technologies, media, software etc that almost everyone has access to. Therefore these arbitrage opportunities are no longer available. Still arbitrageurs exist and try to take benefit.

I keep getting emails form traders losing money while trading however sometimes the losses are so much that I feel like telling you to make sure you are also not in the same page.

Here is the email from my free subscriber I got a few days back. My reply is in bold.

Hello Dilip,

Good day. I have been following your mails and I understand that your courses would help traders earn up-to 5% a month on the capital invested, through options trading. I have done options, strictly CALL and PUT and I have gone through all the trouble and mental stress you were talking about in your mails in 2015.

I lost about Rs.8 Lakhs right from the day I started in stocks from 2010, till 2016. Out of that, 1 lakh I lost in options. I was under the impression that I could gain all my losses, through options, ended up losing 1 more lakh. Other losses being through buying and selling of stocks in cash market, bad judgements, etc.

Well with 99% losers story is same including me 🙂 This is life do not worry.

Even though I am well educated, am not good in math. Probably that could be one of the reasons for my losses, but, it could be my notion. My question is, will I be able to understand and use the strategy of yours effectively, even if I am not good in math and analytical strategies? What level of intelligence would be required to become unfailing in the market?

Not knowing math is NOT a reason to lose money. Yes you will be able to able to understand and use my strategies in live market because it is written that way. Technical Analytic is not required. Class 4 math is required and some hard work. See even people not good in English have done my course and doing good. In simple words it is easy to understand.

Honestly if I had that money I lost, I could have used it in better ways. Sir, I am not asking anything for free from you as I know how frustrating it would be for any one. I had the above doubt in bold above, which I would like you to clarify as you only can answer me.

Lost money is lost money it does not matter where you lost. Now you will not get that money back. Only way out is learn to trade well and make sure you are not losing anymore trading options.

Start learning to trade options well by doing my course today and stop losing money trading options.