URGENT: Is anybody doing this? (Long Fut, Short Call)

#1
Folks

Today evening when I was looking at options data of RIL for March expiry, it struck me that 920 CE closed at Rs 26 and March Fut closed at 926. (Lot size 1000).

Let us say, on Fri (24/2) the market opens flat and one can but RIL fut at 926 and sell 920CE at 26 and hold it till expiry then it can result in the following: -

(Margin reqd is 1.8 L).

1. If expiry is at or above 920 then profit will be 20k (i.e. cool 11% in one month).
2. If expiry is between 920 to 900 then profit will linearly reduce from 20k to zero.
3. Loss start only with expiry below 900.

Plan B: It will be even safer if 900CE is sold at 39. Max profit will be limited to 13k (i.e. 7%) but loss will start only below 887.

Is anybody doing this? This can be done every month with a large cap stock which is either sideways or up-trending? Highly suitable for those in full time job or business.

(Q: For March is ONGC better bet then RIL?)

Thanks in advance
pos_trader
 

suri112000

Well-Known Member
#2
This is called covered call strategy.
It can best be used with equity and Call option writing.
If you are willing to invest in RIL equity qty 1000 at Rs.926 for say more than 5 years. You could trade this strategy.
But, if you trade with futures and option, there is a danger of eroding capital. That is because when RIL crashes by 20% after buy, your MTM loss would blow your account. Whereas if you hold equity shares, you need not to suffer actual loss, but you will be sitting on notional loss which can be slowly offset by writing call options.
 
#3
[QUOTE=".......That is because when RIL crashes by 20% after buy, your MTM loss would blow your account. Whereas if you hold equity shares, you need not to suffer actual loss, but you will be sitting on notional loss which can be slowly offset by writing call options.[/QUOTE]

Suri -- Thanks for your reply (u r the first one :).

My question is not about covered call writing (buy equity sell call). It is about buy fut,sell call (I do not know the name, can someone enlighten me on this)?

About your point - In last 36 months, in how many months did RIL close on the expiry date lower by 20% (from start of expiry) ? The answer to this question will throw light on the risks associated.

Thanks
pos_trader
 

suri112000

Well-Known Member
#4
[QUOTE=".......That is because when RIL crashes by 20% after buy, your MTM loss would blow your account. Whereas if you hold equity shares, you need not to suffer actual loss, but you will be sitting on notional loss which can be slowly offset by writing call options.
Suri -- Thanks for your reply (u r the first one :).

My question is not about covered call writing (buy equity sell call). It is about buy fut,sell call (I do not know the name, can someone enlighten me on this)?

About your point - In last 36 months, in how many months did RIL close on the expiry date lower by 20% (from start of expiry) ? The answer to this question will throw light on the risks associated.

Thanks
pos_trader[/QUOTE]
Even if you use futures instead of equity, it is still called covered call.

When you own equity qty 1000, you keep Rs.10 lakhs as investment. Even if it goes to zero, you can still hold equity because your loss is notional. But instead of equity, if you hold futures, I doubt you would have Rs.10 lakhs in your trading account because RIL margin is around Rs.65000. If you trade this strategy with bare minimum capital, even 10-20% adverse move before expiry will attract auto squaring off by broker. The futures may come back to Rs.900+ levels on expiry date. But you are out of trade because of MTM losses. This is the point I want to highlight.
 
#5
Suri -- Thanks for your reply (u r the first one :).

My question is not about covered call writing (buy equity sell call). It is about buy fut,sell call (I do not know the name, can someone enlighten me on this)?

About your point - In last 36 months, in how many months did RIL close on the expiry date lower by 20% (from start of expiry) ? The answer to this question will throw light on the risks associated.

Thanks
pos_trader
........ The futures may come back to Rs.900+ levels on expiry date. But you are out of trade because of MTM losses. This is the point I want to highlight.[/QUOTE]

Suri -- Thanks for your time. Yes, I take your point on stock price coming down.

If, say, by 20th March RIL cash price is Rs 902 then square up (BUY) 920 CE in good profit and sell 900 CE. What say? Is anybody doing this month after month?

Thanks
pos_trader
 

ncube

Well-Known Member
#6
........ The futures may come back to Rs.900+ levels on expiry date. But you are out of trade because of MTM losses. This is the point I want to highlight.
@pos_trader,

First try answering if are you comfortable shorting puts instead? If comfortable you can directly short puts and if not comfortable then covered call is not the right strategy for you. Because covered call is synthetically same as short puts. You can confirm this with the payoff graph.

The basic formula you should remember is : +Underlying(Equity/Fut) + Puts = +Calls

Covered call: +Equity - Calls = -Puts

If you want to understand more about synthetics you may read the book The Hidden Reality by Charles Cottle. Its a difficult read but there are some impressive concepts explained. Exactly the same question asked by you is given as an example there. Cottle is not a good writer but it seems he was the brain behind the thinkorswim platform.
 
#7
Pos Trader, Ncube is correct, what you are doing is simply covered call writing or reverse of it ( sell underlying and sell PUT)
Think it as you purchase a house and rent it , this is somewhat like that. nothing new

CC as popularly known can be done on any underlying which has options on it so you can use Stock as underlying or Futures as underlying
True that using Futures as underlying is capital effective as compared to using stock as underlying because futures has built in leverage

Whichever ,the risk of the strategy is ( in case of CC) if the underlying tanks in a big way you can loose lot more than the Option premium you gain!
what if you make 4-6% per month ( or your 11% example) for firts few months by selling option and then in 3rd month stock tanks by 25% you cant say it wont happen!
There is a famous saying CC writers eat like king every month but when things go bad they Sxxxx like an emperor!

There are even structured products based on a cousin of this called "married Put) do a google search on "Protected Equity Loans" perhaps not possible in Indian market but....
any way back to your CC idea
Doing this in Indian market is bit more cumbersome ( I believe but not sure)
1) If you sell futures then what is the underlying? for stock option prices are the Indian stock Options based on stock or on Stock futures?
2) Cross margin , because both are cash settled you got to put margin for both!
3) Cash settled so no delivery of underlying meaning if you option is "in the money" you will have to close both legs!
Just my 2 cents worth