Monday, April 13, 2009

A options strategy for those who dare…

Okay guys and gals here goes the story. They say that buying stocks is the trend of the yesteryears. If you are in markets then you have to be in futures and options. I agree and disagree at the same breath. Well the reasoning is very simple. Yes you do make tons of money but then you also loose tons of money. If you are not purely mechanical (I am having a lot of difficulty issue in this respect) then it is very easy to come out of the fight not only bruised but with nothing in the pockets. Infact so much so that at the end of the day you can be without a penny – all the hard saving gone down the drain. But if you are those mechanical types who do not believe in hunches/TA or fundamental analysis then you will make pure sweet green bucks by playing in futures and options. I will throw open a options strategy today (as a study example) with reasoning the whole way through at every little step – so if you are a brave heart and do wanna have some fun – read on and jump in. Please do understand the profits are yours and so are the losses – for me it will remain a study only.

In the first step we will choose a underlying stock or index. So here it goes. (The excel sheet with all data is attached)

  1. I opened the page of NSE-India and scanned through the beta values of the Nifty stocks there. Then I saw and set aside only the stock whose Beta value was more than 1. (You can reach the NSE- Site referred too by Clicking Me) The result was a list of 21 stocks who seem to move with or more than Nifty.
  2. Then I went to the option chain page in NSE and tried to gauge the liquidity of the options of the above 21 scrips. With this step I was left with eight stock options that I consider were liquid enough for us to take positions.
  3. Then I went on to see the Average True range of the six stocks I have short listed.
  4. After that I jotted down the present price of the stock and saw what the ATR meant in terms of percentage of move relative to the stock.
  5. After this I again go back to the options chain and see the listing of the options (call/puts). I compare this with the spacing of options. Here surprisingly there was no in money put available for Tata steel.
  6. Next step was to pick up any one of these stocks and concentrate on them for buying a strategy. I will give example with one only and that is Reliance.
  7. Next was a pain staking step where I calculated the premium, the cost I will pay for the strategy etc.

Well this is pretty much end of the statistics that I want and now what I do next is really what my mind would say so. Ofcourse I do also have a look at the rest of the technicals. What I really expect at this moment is a 50% retracement to the present run up but all the same will want the positions to be well hedged. So keeping the positions I would go in for some straddle / strangle that likely to give me good gains. Remember also that we are in the middle of the month and the decay will kick in fast and hard.

Now again not too much reasoning I can give as to why I have taken the positions but I chose Apr 1740 call and Apr 1800 Put. Firstly the premium is pretty much the minimum and I might have loved to go to 1830 put but the position is illiquid so premium is very high.

Now the brasstracks: -

  • For these positions I will have to pay a total of Rs 54,705/-
  • the strategy pays off below the Rs 1,651/- or above Rs 1,895/-
  • Maximum loss (cost call plus cost put minus 60 multiplied by 300) that is equivalent to 36,705/- and maximum gains unlimited.
  • Days to expiry… 12 trading says.
  • So basically this strategy is trying to make use of directional volatility of more than 122 Rs in any one direction.

With the increase in lot size in most cases the investment has considerably increased. The best for anyone with less than this amount is Nifty.

Do post your comments so that we all can learn and improve upon such investment ideas. The options file that I have been talking about is uploaded to skydrive – please click the link to download it. Options Excel file



r m said...

Someone unwilling to risk Rs 36705 (like me) could also sell 1770PA at 73.55 and 1770CA at 77.60.
This will reduce the initial cash investment to Rs 9360. :)
Maximum loss reduced to Rs 360. :)
Maximum profit reduced to Rs 8640. :(
Margin required - humongous. No problem for those who have plenty of holdings in their demat (not me) :(

r m said...

I believe that the expiry for APR30 series has been advanced to 29APR09 due to election in Maharashtra on 30APR. So there are only 11 trading days left till expiry.

S S Cheema said...

Thanks a ton rm as always. I have still not got around to selling options and thinking about them - so will take me time to think things over. Anyways - thanks - you get my brain rolling.

r m said...


The main problem with selling covered options are:
1. MTM requirements and
2. What if buyer exercises the stock option?

While the first can be dealt with adequate bank balance - there is not enough information on the second. That is why index options are better - they can't be exercised!

S S Cheema said...

Ha - thanks for the input rm. the problem is that the lessons in stock markets are very costly.