Nifty Covered Call

I'm trying to find a trading model basis follows:

1. Which is not very time intrusive.
2. Trading strategy is rather stable. No frequent changes.
3. Which is scalable.
4. Finally and importantly which gives a decent return (>=2% per month)

After trying out various options strategies I thought of Nifty covered call strategy.
1. The fundamental assumption is that India economy in bullish phase. Therefore, irrespective of temporary setbacks, nifty will grow over a period of time.
2. A huge crash - 20-30% in a month followed by recovery is ruled out as of now.
3. This is not alternative to my equity investments. I just shift some of my debt portfolio to this high risk high return strategy.

With this the model is as under:

1. Buy 500 shares of Nifty Bees representing one lot of Nifty. This will entail an investment of Rs. 2.25 lacks at the current level of Nifty.
2. The target is to increase these 500 shares to around 700 shares after one year, irrespective of Nifty levels.
3. Short next month nifty call. Depending upon the view of market the strike price can be determined. (Bullish: OTM, Bearish: ITM, Sideways: ATM)
4. The initial premium received would be around 3-5%, up to which is the protection on the downside and which limits the upside.
5. If market moves sideways, there would be time decay of around 2% which is the net return.
6. One needs to play on market volatility to protect the loss. As this model fails if there are sharp movements in the market in short span of time.

I would initiate the strategy next week by buying 500 Nifty bees and shorting one call of December series probably at strike price of Rs. 5000.

I will go slow in the initial few months refining my strategy before scaling it up.

Would sincerely appreciate the views as I'm still hazy in my mind in certain areas.

The strategy is interesting as you are buying the underlying by paying the complete amount. The market will not fall 20% is your assumption. What if it falls? How do you protect yourself in that case?
Let us look at a hypothetical case

NF at 5000. 5000CE and 5000PE at 150/- each. We take the trade when NF is at strike price.

Buy 1000 Nifty bees @ 5000/- Investment 500000/-
Sell 2 lots of 5000 Call that has the max time value at 150/- (Margin blocked say 70000/)
Amount Recd: 15000/-. By expiry if NF is at any point above 5000, you pocket 15000/-.
15000 on 570000 is a return of 2.63% Not bad at all.
What happens if NF tanks below 5000? Your breakeven is 5000-150=4850 on the niftybees. No money is lost if NF closes between 4850 and 5000. For every point it closes below 4850 you lose one points on your position, on NiftyBees.
Hence if NF ends at 4750, and you have to close both positions, you lose, (10000/- long NBees). The loss on NBees can always be considered notional as you do not have to book it. If we do not consider the loss on NBees, then you lose nothng if NF closes below 5000.
Consider this
You buy 1000 NBees at 5000. Investment: 500000/-
You sell a straddle instead of just a call. Sell 2 lots 5000CE and 5000PE at 150/- each.(Margin blocked 140000/-)
Income from straddle: 30000/-
NF expires anywhere above 5000, you pocket 30000/-. (Return of 4.68% on investment of 640000/-)
On the downside, you have protection till 4700 on short straddle.
NF ends at 4700, loss on NBees: 30000/-
Inflow from straddle: 30000/-
Outflow on straddle: 30000/-
Again the loss on NBees is only deterioration of investment rather than a real loss.
What do you do if NF goes below 4700?. Well you need protection here.

Suppose at the time of intiating the straddle you also buy 2 lots of 4700PE at say 40/-. That will cost you 4000/-.
So your income from the options position reduces to 26000/- (30000/- from straddle less 4000/- from Long 4700PEs).
So your profit if NF closes above 5000 will be 26000 a return of 4.06% on your investment. Also you have protected yourself on the straddle completely. Loss now is only notional on NBees for any close below 5000. If NF moves to say 5300, you could always consider closing 5000PE which may be around 30-40 thus completely locking in your profits at around 3.5%

Advantages of doing this strategy with NBees instead of NF is that you do not have to book losses in NBees and do the rollover into the next month with the same position, whereas with NF you have to book the loss and then roll over.

Thanks for such an elaborate reply.

The straddles strategy is definitely interesting. Will definitely evaluate it, if not immediately, as I want to start with simple strategy.

Regarding, my stated strategy i.e. buying underlying and selling short CE, I pocket the margin if nifty goes down and not if it goes up. Therefore, on downside I lose only 1 point on my underlying.

I lose money on my short CE if nifty goes up, but makes notional gain on my underlying.

Net-net, whenever I close my current position on CE, in case of profit on CE (if market gone down) I buy equivalent Nifty bees and in case of loss (if market gone up) or I withdraw the money to make up my loss. My target is 30-40% gain in quantity terms at the end of 12 months irrespective of nifty levels.

Have corrected the calculation. Thanks for pointing that out.

Nice explanation of income strategy TT.
If I have to trade this - then I won't block my 5lacs in Bees.. but use that money as margin for short Straddle. So I can short 7 lots of straddle (assuming 70k margin for each short straddle).
So collect (150+150)*7*50 = 105 k.
To protect, I buy 4700 put, and 5300 call. Even if I have to pay 40 rs for each, My protection cost will be (40+40)*7*50 = 28k
Giving me risk free maximum collection of 77k. If market zooms then I may not make any return in a month..but will not loose any penny of my portfolio either due to the protective puts.

Short straddle give max return when mkt expires at the strike price sold which is difficult to hit. so you will never get max return from a straddle.

Huzzu - Covered call strategy is not that risk free as it seems. It is equivalent to Selling Naked Put i.e. with no protection.
In both these strategies, u collect small amt as premium, limit your upside return, and open to huge risk when mkt falls beyond the limit that u collected as premium.
So I would rather go for writting more contracts of naked put, rather then going for covered call and spending hugh cash to buy underlying. Maybe more intelligent approach will be to buy some FAR OTM protective puts (that will limit my loss in black swan market crash events) by compromising part of premium collected.

Happy trading

hi..
when u buy nifty bees u have to put in money, again u have 2 shell out margin for shorting the otm call. why dont u just sell an otm nifty put. the risk 2 reward is exactly the same & u have 2 pay a single margin.
regards

Anurag

Niftybees in long term can fetch 15% annulaized return. If we can earn extra around 5 to 10% by writing calls and buying puts we can maximise our returns to the tune of 20-25% .

Is this possible to get 25% annualised return on our investment on nifty bees ?