Does the Pareto principle (also known as the 80/20 rule) apply to stock trading?
An options seller – also known as an options seller – makes money in four out of five possible outcomes, unlike an options buyer who makes money in only one.
That’s how PR Sundar puts it. He is a math teacher turned trader and trainer based in Chennai.
In Sundar’s words, an options seller only loses money if the market falls violently out of favor, and makes money if he:
“So it may be appropriate to say that the option seller has an 80% chance of winning, unlike the option buyer, who only has a 20% chance,” he said in an interview. at CNBCTV18.com.
However, it is not that simple. Selling options works differently than buying options. An options seller has to deposit margin money based on the value of the contract as collateral, which is far more than what a buying counterparty has to pay. This amount is decided by the exchange and varies from time to time.
An option buyer, on the other hand, only has to pay the option premium up front and not the full contract price.
This is why an options buyer has limited liability – in the form of the premium paid – but an options seller has potentially unlimited losses.
“There is no such thing as entering the market safely…Markets are subject to risk… If you have the right skills like any other business, you don’t have to worry. Every business is unique and needs a different type of capital requirement,” he said.
“Although we don’t have data on the percentage of options buyers who make a profit, if 99% of traders do not beat fixed deposit returns over a long period of time, we can logically conclude that many buyers options lose several small amounts that become profits to some HNI clients who are sellers with huge capital,” Sundar said.
Zerodha CEO Nithin Kamath had said in January 2022 on Twitter that only 1% of active traders beat FDs over three years.
I am surprised that so many people are surprised that only 1% of active traders make more than fixed bank deposits over a 3 year period. Active trading is like running a business, only a small % are successful. The only easy part of trading is to start trading. 1/3https://t.co/dz4LGrTLRo
— Nithin Kamath (@Nithin0dha) January 4, 2022
Is there an all-weather strategy for options traders?
Sundar identifies himself as an options seller, not a buyer. However, he buys options as part of his strategy, like a ratio spread.
“Normally I only do straddles, chokes and ratio spreads in all market conditions, but as the VIX gets higher, I reduce the volume. If the VIX is above 30, I try to stay away from the markets,” he said.
Straddle, strangle and ratio spreads are market neutral trading strategies used to limit the risk incurred in the event of an adverse market movement.
The India VIX – known in market parlance as the Fear Index – is a measure of the expectation of volatility in the market. Apart from the general feeling of fear, it also determines how far the market can move in a given period in one direction or the other.
Is there easy money in the options?
“Where you can make money easily, you can also lose money easily,” said Sundar, who describes the stock market, derivatives (futures and options) in particular, as “the hardest place to make money. money easily”. Derivatives are leveraged products where your reward is higher but proportionally the risk is also higher, he said.
Earning Money vs Creating Wealth: Is There a Difference?
Money can be made by trading with the right skills. That’s what Sundar thinks.
“Normally trading is like business, you don’t make fantastic returns but decent returns for your capital. So trade, earn money and invest the profits for long term wealth building. Trading is all about making money and investing is about creating wealth,” he explained.
“Options writing can be done with capital as low as Rs 25,000. It all depends on whether you are a part-time or full-time trader, your risk appetite and return expectations, etc.”, a he declared.
But a word of warning: “There must be enough reserve liquidity if you want to make adjustment trades in case an existing trade goes wrong.”
Sundar suggests those looking to get into trading stick to index derivatives and not equity derivatives. This is to avoid higher margin requirements for equity derivatives. Index derivatives – which include a pool of stocks – don’t tend to move as violently.
Over the years, he has moved from teaching math to students to teaching business to adults. It has had around 3,000 students over the past 3-4 years.
Asked about common traits between math and trading students, he said, “Those with a strong math background also generally have good analytical skills. They have a slight edge because trading involves a lot of strategizing and quick decision making. . Enthusiastic students in both fields tend to be very curious.”
“Teaching is not a lucrative job. Besides, I have already spent 20 years in education, so I turned to trading even though they seem unrelated,” Sundar said, who has a trading portfolio of Rs 40-50 crore.
Sundar does not describe himself as an expert fundamental analyst or an expert technical analyst, but as a strategist. To be a strategist, his background in mathematics helped him to some extent. In his own words, he “knows nothing but teaching and business”.