“Options” and the “overconfidence bias”

 

Option trading has always been lucrative for retail investors. They buy options expecting it to turn into a jackpot that will woo away all their worries. In this article am going to share the story of Nitin and discuss one of his recent trades.

Nitin was away from the futures and options for about one and a half years after he realized it to be more of a “zero-sum game”. From his past experiences, he was aware that one can make decent profits in a single trade and can lose 2x or 3x of it on the other.

 So, here’s the story.

 On 14 January 2021, at around 1 PM, he got a notification on his mobile.

 “Jubilant FoodWorks to consider subdivision/stock split on Feb 2”.

 The news was during the market hours and was not very much spread over the internet. Also, a day before, he had come to know that the lot size of Jubilant is only 125 and hence required less capital and so the risk.

 The stock was trading at around 3940 and he initially took ‘x’ lots of CE 4200 (call option). There was some movement on the upside, and he traded twice to earn some profits. After the initial two trades, greed took over. He attempted for the third one anticipating that the price will rise, if not today then surely before expiry, which was still more than a week away. However, the overall market was showing some weakness and the stock price too moved a bit lower. His conviction or the ‘overconfidence bias’ led him to average the price with more lots. However, the stock price couldn’t recover, and the CE 4200 closed at around 33 (while his average price was about Rs. 43).

 He carried over the position for next week (15 & 16 Jan being the weekend).

 This is what happened to NIFTY and the stock the next Monday.

 NIFTY 50

Jubilant FoodWorks

There was a selling spree in the broader markets with FIIs withdrawing money from the Indian market. Reason???

-        High inflation

-        Upcoming FED’s meeting and the chances of an interest rate hike

-        Tussle between Russia and the USA over Ukraine

-        Various rumors related to the Indian budget

 

The greater the fall, the more the rumors and the reasons. Nitin was still confident of Jubilant FoodWorks and the overall market recovering before the expiry as the budget and the Jubilant’s Board meeting, both were in the first week of February. He did some averaging again on Monday and for the rest of the week kept hoping for a bounce bank.

 

In general, the news of a stock split pushes the stock to the upper levels as it would become more liquid and convenient for retail investors to trade. However, Jubilant FoodWorks went the other way. The price kept falling to near 3300 on the day of expiry. Though he exited his position a couple of days before the expiry, he had already realized a significant loss due to his ‘overconfidence’ and the lack of risk management practices.  

The only way to be profitable in F&O is when you have a proper trading system that minimizes the emotional interference and is a system built on a strong risk management framework (also, to have a better probability of profits you need to be an option seller than a buyer). Additionally, you should have a strong knowledge of various trading strategies such as straddles, butterfly, etc.  

Until and unless these are in place and you are still making profits, consider it as your luck!

Moral of the story:

-        Do not fall in love with a stock and keep hoping for a possible up move

-        Be cautious while carrying a position (in options) overnight, especially over the weekend

-        Markets are not driven by the retail investors; any event may have already been reflected in the stock price before actually becoming ‘news’. According to the Efficient Markets Hypothesis (EMH), the asset prices incorporate all available information.