Two way option trade on volatile stokcs: good or bad

yoogi · #1 29th June 2007, 06:21 PM

I dont know how option prices are calculated, but it appears that on stocks with higher volatility, if I hedge on either side of share price, I am more likely to gain, than to loose. Is that correct?

Today, I bought balrampur chini july 26 option, when the share was around 73.
75-rs-call @ 3.80,

and when seeing the stock goes below 73, to 72 I got scared and I bought
70-rs-put @ 2.65.

I thought I hedged it, with a loss.

My idea was that the stock, given that it was up about 9% at that time, should either move up or down 4% next day. So I wanted to check the status only next day.

Then I started my regular work. (I am not an active trader). In the evening when I took a peek, i was getting about 50 paise profit from squaring off both positions. I did just that, esp b;cos I wanted to make sure I avoid brokerage in ICICI by squaring off on same day.

sunil saranjame · #2 29th June 2007, 10:00 PM

Quote:

Originally Posted by yoogi

I dont know how option prices are calculated, but it appears that on stocks with higher volatility, if I hedge on either side of share price, I am more likely to gain, than to loose. Is that correct?

Today, I bought balrampur chini july 26 option, when the share was around 73.
75-rs-call @ 3.80,

and when seeing the stock goes below 73, to 72 I got scared and I bought
70-rs-put @ 2.65.

I thought I hedged it, with a loss.

My idea was that the stock, given that it was up about 9% at that time, should either move up or down 4% next day. So I wanted to check the status only next day.

Then I started my regular work. (I am not an active trader). In the evening when I took a peek, i was getting about 50 paise profit from squaring off both positions. I did just that, esp b;cos I wanted to make sure I avoid brokerage in ICICI by squaring off on same day.

What you have done is that you bought a Strangle. This strategy is used when you think that the underlying will be very volatile. Upside potential is unlimited - should the underlying fall or rise greatly. There is nothing good or bad, as long as you make money.

ss

yoogi · #3 29th June 2007, 10:08 PM

So if a stock is volatile (say like how unitech, RNRL, IFCI sugar stocks behave these days..) this strangle could give a trader some money..

The money could be much less than a directional call, but it is sure to make some money. isn't it?

desi123 · #4 30th June 2007, 08:44 AM

well, lets take your trade for Example. Your Breakeven prices are 81.45 on upper side and 63.55 on lower side. Hence, theoeretically, prices have to break either above or below the same for you to make money.

This is a high risk strategy since amount of investment is huge and most of it (if not all) is only premium which depreciates with time. Instead what you could have done is Sell a 80 Call when you were afraid of market falling and reduce the amount of risk instead of buying the put and adding to the risk.

Cheers

DT

yoogi · #5 30th June 2007, 09:23 AM

No desi, I guess my break even are far less than that, espcially if I colse it quickly.

When the share price reaches 78.80, within few days, I can sell 75 call for a better premium and I can still sell the 70-put for a decent value (given that there is still lot of time left) and get all money back + some more.

On the down side also, if the share slumps to 67.35, i will get some money (for downside premium + still some upside intrest in market).

I guess I loose money only when the stock trades in the same range of 71-74 rs for next 3-5 days. If the stock either breaks out or breaks down, I will have some money on the table. How much & how soon it goes up or down decides how much I will get.

That is what precisely happened.

I am not at all familiar with alpha calculations, options pricing strategy. It is my fear that made be bought a put call. After having made a gain, I wanted to find out why I gained? I am relatively comfortable at stats and maths. In this forum I read about alpha neutral strategy.

Still I havent grasped all concepts of option greek.

But I guess, if one buys on an alpha neutral strategy, it does not remain neutral when price changes (no matter which side it changes) and all other things being equal (ie, on same day.. number of days remains the same), it has a positive bias for the buyer.

This will be much better if one makes it exactly in between support and resistance (say half way), and the prices are much closer to the current price.

desi123 · #6 30th June 2007, 10:52 PM

Its not Alpha, its Delta.

Delta Neutral doesnt make you money no matter where market moves. Delta Neutral strategy is used where in Instrinsic Value movement is less and much of the profit occurs from decay of Theta (Time).

Cheers

DT

desi123 · #7 30th June 2007, 10:53 PM

Breakeven I gave was for Expiry and yes, you can be in profit if major moves happen early.

Cheers

DT

mangalorebull · #8 13th July 2007, 08:05 AM

Dear pal,
The problem in initially selling a call is that you become an option writer and that calls for huge margin money.For Nifty it is around 20K an option but it is much higher for individual stocks and more so for volatile stocks,
regards
mb

Quote:

Originally Posted by desi123

well, lets take your trade for Example. Your Breakeven prices are 81.45 on upper side and 63.55 on lower side. Hence, theoeretically, prices have to break either above or below the same for you to make money.

This is a high risk strategy since amount of investment is huge and most of it (if not all) is only premium which depreciates with time. Instead what you could have done is Sell a 80 Call when you were afraid of market falling and reduce the amount of risk instead of buying the put and adding to the risk.

Cheers

DT

desi123 · #9 14th July 2007, 11:31 PM

When you do a Covered Call, Margin is lower than what is required for selling / Buying a Future or a Naked Call. All the same, I believe capital is a huge requirement for trading in F&O and without adequate capital, it would be un-wise to trade in this segment.

I also look at more of capital protection and Return on Equity.

Cheers

DT

mangalorebull · #10 14th July 2007, 11:44 PM

dear desi123
Yeah a covered call is less heavy on margins.
For example, selling a nifty call along with put option at same strike(straddle) gives you about 60% concession one way.20K for 1 way and about 8.5 K the other way.Still thats a lot.
regards
mb

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