Algorithmic Options trading is fast gaining traction as a way to get a better grip of the Options trading space. Though Option trading is well explained most basic trading tutorials, a good recap will help you place this in context. Options are essentially a kind of contract that allows buyers the right to buy or sell the underlying asset at a specific price on a certain date, but there is no obligation.
Generally, Options are used by people to hedge their risks, and when this is traded algorithmically, it is known as algorithmic options trading. Technically, algorithmic trading follows a definitive set of pre-defined instructions to take positions, but unlike the completely automated process, it is more perceptive to changing market scenarios. It brings about a systematic order to your options trade and no doubt it opens up a better liquidity position in the market.
Difference between Algorithmic Trading and Automated Trading
Before we move any further about algorithmic options trading, it is important to clarify that algorithmic trading is not always the same as automated training. Algorithmic trading is dictated by a set of rules that help in decision making (buying/selling). These rules are formulated after backtesting over years of historical data.
However, this is often confused with automated trading. In the case of automated trading, the trade execution doesn’t require any human intervention. If your algorithm signals a trade, it is immediately executed through the automated trading system. It would be fair to say that automated trading is just a subset of algorithmic trading.
Algorithmic Options Trading Tools
It goes without saying that for the successful execution of Algorithmic Options trading, the trading tool is crucial. It helps you develop a well-allocated trading system that assures definitive profit. This is often the key to a great trading experience.
Amibroker: As investors are gradually getting tech-savvy, Amibroker is turning out to be one of the most popular trading analysis software for executing Options trade. The low license cost also makes it particularly lucrative. With more number of people using it, this also adds to the community feel and creates a cycle of trust around this tool specializing in executing these types of algorithmic trades. But remember, this is not a trading terminal but more of an analysis tool.
Metatrader: It is a multi-asset platform. You can use this for trading Options across asset classes like stocks, forex, and a lot more. It is easily accessible for a wide range of trading terminals and gives investors the luxury of choice and maximizing profit in a definitive manner.
eToro: This is more of a social networking platform that facilitates the easy execution of an options trade. This is because you have traders from across the globe connecting on this platform and exchanging trading strategies. It is compliant with most technology and software and easily helps you to access several ideas with ease.
Robinhood: This is a free trading service, but it is better designed for stocks compared to options, However, if you can adapt your investment needs with the software and its offerings, it can help you reap rich benefits.
Algorithmic trading, especially in case of options, needs to be complemented with a good and definitive trading tool. This helps improve the speed and efficiency of the trade, and as a result, you can book better and more long-lasting gains from the same.
How Algorithmic Options Trading differs from Stocks and Commodities?
It will be wrong to paint all forms of algorithmic trading in one brush stroke. Options trading undertaken using algorithmic strategies have some definitively distinctive characteristic features.
Greater dimension to trade: Unlike stocks and commodities, there are greater dimensions to consider in Options trading. For example, profit and losses in stocks depend only on the prices. But that is not the case in Options. In this case, the volatility, prices moving in and out of range, and many other factors.
No exit commission for expired options: This is one trade you can simply fire and forget. The algorithms used for these options can be on a selective basis, and this brings about great flexibility to the overall trade.
Better leverage: It also offers traders definitively higher leverage. That, in many ways, makes greater chances of profit. For even a limited sum, you can play on a much large asset base compared to stocks or commodities. This makes it a significantly more reliable form of trading using the advantage of algorithms.
More advantage to sellers: The premium protects the sellers’ profit even if the underlying trade does not follow a well-marked out chart. It can still help in producing profit for the seller and keeping the relative risk in the trade contained to a large extent.
Options Strategies: Traders can opt for several multi-legged option strategies based on market conditions. There are choices among bullish, bearish, and delta-neutral strategies that can be executed to increase your profits with low risk. The trading algorithms can also suggest one of these strategies based on the underlying price and various technical indicators.
Also Read: How to pick best stocks for Options Trading?
The Risk factor and ways to Backtest Trading Strategies
There are, however, certain risks associated with this algorithmic options trading:
Network connectivity and time-lag: This is particularly a critical aspect if you are handling rather volatile trades. Make sure that the algorithm considers slippages during backtesting, otherwise, the results may not be practical.
Real risk limit: We have often noticed that a short position in a stock can wipe away your gains. But you can avoid this risk in options by combining positions and bringing in place a real risk limit. This is also a direct outcome of effective backtesting of strategies.
Therefore, backtesting an algorithm strategy is one of the most effective ways to contain the risk factor in the options trade. The availability of historical data is crucial for proper backtesting. This yields proper and far-reaching results.
How Technical Analysis could Help?
The other option to maximize profitability is to take help of technical analysis. You can always refer to related technical strategies to identify the trend, moving average, and the arbitrage potential of a particular trade.
The plethora of technical tools and analysis depend on historical data and the brilliance of using past trends to predict future movement. In fact, these are also amongst the easiest to implement in algorithmic trade as they have clearly marked out entry and exit points.
Also Read: How to trade Options using Market profile?
Algorithmic Options trading may be certainly helpful but should be practiced with caution. Especially in the case of multi-legged strategies, you’ll need to make sure that all the legs of the trade are executed at nearly the same time, otherwise, the strategy becomes meaningless.
One biggest advantage of algorithmic options trading is that you can have a more predictable trading routine. Since your strategy would already be backtested on historical data, you will have an idea of its profitability and drawdowns in advance which is certainly helpful.