Short selling faroff options!

prasham

Active Member
#1
About a quarter back a friend suggested me this technique. He had a very simple technique regarding earning small amount of money out of options. This is what he does...

Say Nifty is at 5000 in the current month, he would short sell 4400 PE and 5600 CE of the next month and wait till the expiry (mostly). According to him due to the time decay factor both these call/put would eventually loose value and hence earn you some money without much risk. He says he is doing it since about a year now with moderate profits.

What are your expert views on this technique? I am a newbie to option trading so can't make up my mind regarding this.
 

rkkarnani

Well-Known Member
#3

trader.trends

Well-Known Member
#4
About a quarter back a friend suggested me this technique. He had a very simple technique regarding earning small amount of money out of options. This is what he does...

Say Nifty is at 5000 in the current month, he would short sell 4400 PE and 5600 CE of the next month and wait till the expiry (mostly). According to him due to the time decay factor both these call/put would eventually loose value and hence earn you some money without much risk. He says he is doing it since about a year now with moderate profits.

What are your expert views on this technique? I am a newbie to option trading so can't make up my mind regarding this.
Prasham
There are many people who follow such techniques. To take your example and work out the math:
5600CE is at 12.30 and 4400 PE is at 15.20 while the Nifty is at 5080. If you sell one lot each you get to pocket a gross of 1375/-. If you need to block cash you need at least 50000/- to sell these options. You can also sell them against your long term portfolio which means you are using your existing portfolio more efficiently. Assuming you hold it for a month that is a return of 2.75% per month or an annualized 33%. That is a fantastic return compared to the bank rate.

Next is to understand the risk involved. As long as the Nifty stays between the strike prices you are completely safe. In the event it moves out of that range then your losses can begin. But smart option writers know how to handle such a scenario. In ten out of twelve months, Nifty does expire between such wide ranges giving you a good probability of making a decent returns.

In my view, a trader has to have a basket of products in his trading portfolio. One would be a income generation product like this which gives you regular income to meet some of the bills. A certain portion towards long term investments. And another portion alloted to higher risk higher reward products like trading in NF or different options strategy.

Don't for a moment believe the trash that option seller make small money but take unlimited risk. If anything I believe it is the naked option buyer who takes unlimited risk as there is a good chance that he will lose his entire investment in the premium.
 

rkkarnani

Well-Known Member
#5
Prasham
There are many people who follow such techniques. To take your example and work out the math:
5600CE is at 12.30 and 4400 PE is at 15.20 while the Nifty is at 5080. If you sell one lot each you get to pocket a gross of 1375/-. If you need to block cash you need at least 50000/- to sell these options. You can also sell them against your long term portfolio which means you are using your existing portfolio more efficiently. Assuming you hold it for a month that is a return of 2.75% per month or an annualized 33%. That is a fantastic return compared to the bank rate.

Next is to understand the risk involved. As long as the Nifty stays between the strike prices you are completely safe. In the event it moves out of that range then your losses can begin. But smart option writers know how to handle such a scenario. In ten out of twelve months, Nifty does expire between such wide ranges giving you a good probability of making a decent returns.

In my view, a trader has to have a basket of products in his trading portfolio. One would be a income generation product like this which gives you regular income to meet some of the bills. A certain portion towards long term investments. And another portion alloted to higher risk higher reward products like trading in NF or different options strategy.

Don't for a moment believe the trash that option seller make small money but take unlimited risk. If anything I believe it is the naked option buyer who takes unlimited risk as there is a good chance that he will lose his entire investment in the premium.
Very Very well said!!! Totally agree with you!!! Yes, one has to be smart!!!
 

bunny

Well-Known Member
#6
Hi RKK and TT,

Can you guys explain me what to do in case you write an option an the price starts going against you? Can you simply cover the position by buying the option?
 

simple_trader

Well-Known Member
#7
Most of the cases option writers make money, but there are some cases, when option writers lose money heavily. May be, we should be careful about those points.

1. Big events, it is better not to write anything before big events like Budget, election results. But it would be difficult to know if there is any global events.

2. Also when market in a range for long like, then it is time to be careful in writing. Currently market is in range for sometime, weekly band is getting narrower, hence it is a possibility to breakout or breakdown in near future (may take a couple of more expires).

These are my own thinking.
 

trader.trends

Well-Known Member
#8
Hi RKK and TT,

Can you guys explain me what to do in case you write an option an the price starts going against you? Can you simply cover the position by buying the option?
Bunny

You can cover it any time you like. I would always suggest trading a spread for beginners. Both Credit and Debit Spread. Nothing like getting your feet wet with small capital. AW10 has the remarkable thread going on Spreads. Best place to begin.
 
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trader.trends

Well-Known Member
#9
Most of the cases option writers make money, but there are some cases, when option writers lose money heavily. May be, we should be careful about those points.

1. Big events, it is better not to write anything before big events like Budget, election results. But it would be difficult to know if there is any global events.

2. Also when market in a range for long like, then it is time to be careful in writing. Currently market is in range for sometime, weekly band is getting narrower, hence it is a possibility to breakout or breakdown in near future (may take a couple of more expires).

These are my own thinking.
Simple Trader

You are right about the risk of writing options before a big event. But if you look a little deeper you will find that options become costlier before a major event. Both Puts and Calls will be costlier. The option writers also know that there is a big event ahead hence charge a higher premium for writing options.

Essentially there is one big difference between buyers and seller at this time. The option buyers would be taking a directional bet on one side, mostly. Most often is is naked option buying. Whereas the seller would be taking a less risky positions like selling call/Put spreads, Selling calender spreads, Selling options but covering it with futures in the same direction. Most option sellers are professionals who have oodles of experience in assessing risks. This is not to say that they will not lose money. This is to say that they have a deeper arsenal to protect their trades.

The option buying can also be a safe trade if it is done in a mature manner where returns are more realistic. Unfortunately, the option buyer falls for the hype of Unlimited Profits and Limited Risk that the brokerage houses and analysts peddle before him.

In an intra day trade, many traders who buy a stock at 100 would be delighted to sell at 103. How many option buyers will sell at even say 108 (bought at 100) giving them the better return even after higher costs? He would be waiting for the mythical Unlimited returns.
 

bunny

Well-Known Member
#10
Bunny

You can cover it any time you like. I would always suggest trading a spread for beginners. Both Credit and Debit Spread. Nothing like getting your feet wet with small capital. AW10 has the remarkable thread going on Spreads. Best place to begin.
Thanks TT.
 

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