With the second half of expiry and truncated weeks, often than not, these additional trading intervals like the ones in August manages to push a lot of Option Buyers into undue losses.
With the second half of expiry and truncated weeks, I couldn’t help but share my learnings in Option selling. Because more often than not, these additional trading intervals, like the ones in August, manage to push a lot of Option Buyers into undue losses.
I say undue because the price action favors, yet the time value decay creates a bigger dent to not end up making any money.
The solution lies in slight aggressive alteration to the directional options trading.
We are all fairly familiar with the basic time value decay handling mechanism. Like not carrying over Long(bought) Options over the weekend or creating spreads essentially Buy a Call/Put Option sell higher call/ lower Put of the strike close to the target, in case the view is positional to fund the decay in the time value of the option bought.
However, even these techniques may not prove to be effective, if you are in a month like August where last two out of three weeks are truncated.
A simple 5 sessions long view could take over 8 calendar days to materialize. In situations like time value, efficient strategy is Ratio Spread.
The strategy is very simple just like normal Bull Call/ Bear Put Spreads, Buy a Call/Put and Sell a higher Call/ Lower Put.
The only difference is this time. While buying, Buy one lot but while selling Sell 2 Lots. What this is essentially expected to do is to fund for a little extra for time value decay in the option bought. Great idea right?
Wrong. There is a Greek letter Gamma, which disagrees.
Well, not complicating it much, Gamma is a characteristic of Option Premium movement across Underlying Price, which says the rate of rise in option premium would be higher with every subsequent favorable move in the under lying price.
In simple English, 100 Call Option trading at 10 with Underlying at 100 would be 15 (5 up) when underlying goes to 110, but would be 23 ( 8 up ) if underlying goes to 120.
Now, remember we have shorted 2 options. While 1st option sold would have less than proportionate losses than the gains in the option bought. But the 2nd option would eat away from the profit.
Now, the entire idea of getting that extra comfort from extra time value decay goes for a toss when the move comes too fast and too soon.
Hence, remember these two points:
#1 Create this trade only when we have more intervals than usual and we are closer to expiry (Speed of time decay is faster closer to expiry)
#2 Follow the execution guide
The Execution Guide:
• Let us say we decide to create a Buy 100 CE & Sell 2 Lots 110 CE ratio with view panning over 3 sessions (5 calendar days).
• Now, there are many free option premium calculators available. Put the current details of both the options (Underlying Value = Futures Price, Time to Expiry, Premium, Interest Rate= 0; Dividend Yield = 0) & get the Implied Volatility (IV).
• Use that IV and the rest of the factors to find out what the premium would be if the underlying would hit your target today itself.
• Compare those 2 prices with the current prices. The Loss Figure that you get is your stop loss in Rupee terms. This is your exit strategy.
• And your P/L would range between this Loss Figure and (Difference of strikes – Net Premium Paid) depending upon when the target is achieved.
MORE WILL UPDATE SOON!!
Comments
Post a Comment