Newbie seeking clarification on a short strangle trading strategy *long post warning*

Hello,

First of all, I would like to begin by voicing my appreciation for the Traderji community for having put up a wealth of information here on this forum.

I discovered this forum last month, and have since then gone through quite some threads from start to finish. Along the way I have received a lot of knowledge from senior members and I wish to thank them all here in my first post.

I am a young engineering professional, and have no experience of the share market. Having said that, I find both T.A. and F.A. very interesting. I am drawn to options because of the sheer amount of permutations and combinations every trade presents.

I plan to be a midterm investor, and like every mid-term investor has a Jekyll and Hyde Personality, I will be swing trading too, holding stocks for a couple of days or weeks at times. This apart I also see myself dabbling in options trading in a couple of months.

That is a pretty lengthy introduction.

I will list out the books I have read during the past 3-4 months during my research for T.A., F.A., Stocks and Options trading, Portfolio Management, Risk and Reward, Trading size etc.

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Books that I have read and will be using while trading -

Technical Analysis from A-to-Z - Steven B. Achelis - This is my handbook for T.A.

Trading with Candlestick Charts - Clive Lambert - This is my handbook for candlestick patterns.

Futures and Options - A.N. Sridhar - The book I refer for all options related queries.


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Books I read for basic knowledge and which I will use for reference -

How to Make Money Trading with Charts - Ashwani Gujral - Nice analysis on Indian Stock Market, which is difficult to find since almost all good books are by foreign authors.

Stock Market Trading Rules - William F. Eng - A set of 50 trading rules.

Technical Analysis Plain and Simple - Michael N. Kahn

Guide to Technical Analysis and Candlesticks - Ravi Patel - Very basic introductory book for T.A.

A beginner's guide to Profitable Investment in Shares - S.S. Grewal

Personal Investment and Tax Planning - Y.J. Yasaswy

DSIJ's Stock Market Book - BSE - The basics and history of Indian stock market

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Any other recommended, please let me know.

Alright, onto my thoughts on Options trading.

From what I have been following it appears that our stock markets tend to be trending roughly 30% of the time, and trading for the rest of the time. I know all generalities are to be avoided since the market is a beast, but that is how it appears so far.

So over the last 2-3 days I began thinking that if I could take advantage of the trading periods by using a short strangle, and the trending periods by using bear or bull spreads, I could make some money consistently every month.

For the first year I only plan to have a trading capital of 100000 rs. and I plan to put in not more than 5000 rs. in buying a spread position in a trending market. As long as I do not close that position, I will not enter another trade.

In case of selling options for short strangle, each position should last me 2 weeks to make a profit on the time decay I suppose, unless I have to unwind my naked shorts in a hurry if the market rushes in either direction.

The following paper trade on Nifty options was executed on 19th october.

Please note that this is a blind trade. There has been NO analysis of the market eod data BEFORE the trade. I will only be reacting to the market AFTER making my blind trade to enable me to take decisions ruthlessly if the market hits me hard. It will become more clear after the end of this trade that I post. At this point I am only looking at the mechanics of the option trade and not looking to predict the movement of the market. Keeping this in mind, even if it looks foolish that I am selling a strangle in a trending market, please bear with me and analyse my strategy. All trades are 1 lot.

19th October - The market was at 6027.

I shorted a Call @ 6200 for 28th October expiry @21.30. That credited my account with 1065 rs. minus brokerage, say 10rs for R.K. Global

I shorted a Put @ 5800 for same month @19.60 which credited my account with 980 rs. minus brokerage.

As long as the market stayed within the 5759 to 6240 range I wouldn't have lost anything. If the market stayed within 5800 and 6200, I would make a profit of 2025 rs after brokerage.

The Coal India IPO happened, and it took the market upward by about 119 points on 21st october. I reviewed my position at EOD on 21st october and this is what I had.

The short call @ 6200 had risen in value to near 30 rupees.
The short put @ 5800 had fallen in value to near 4.5 rupees.

The market was above 6100, and with another strong day it could very well breach my 6200 trading range. Since these shorts were naked, I could be in trouble very soon. It was clear that with one week remaining, the short put @ 5800 was going to give me full value, so there was no need to touch it.

I unwound my short call @ 6200 at near 30 rupees. That meant a debit of 1500 on that position. My profit reduced from 2025 to 2025-1500 = 500 rs. approx.

Now, my first thought was to short a 6300 call. That would increase my safe range by exactly the same amount that the market moved.

The short call @ 6300 for the same month was available at 10.15, giving me net credit of 500 rupees after brokerage.

That increased my profit from the new position of 5800 short put and 6300 short call to around 1000 rs, assuming I held it till expiry.

But what if the market keeps continuing onwards? I will have to keep liquidating my short call at a loss, and shifting it forwards to recover the loss and get some money for my headache.

I decided to sell two far OTM options instead of the 6300 call.

So I shorted a call at 6400 @ 3.65 which credited me with 175 rupees approx after brokerage.
I shorted a put at 5700 @ 1.95 which credited me with 90 rupees approx after brokerage.

Put together these two trades did not cover the 455 loss I had to eat to unwind my original 6200 call. Also, I was now pumping in 30% more margin money to hold on to the position, reducing my profit percentage.

So I decided to scrap the OTM sale (It is a paper trade so I can). Since the market moved UP by 100 points, I wondered if I could sell a 5900 put, which would be a 100 points above the 5800 put. So I tried that.

So I shorted a 5900 put available for around 9 rupees, which fully covered my loss in unwinding the 6200 short call. Also the only criteria left in the position was that the market stay above the 5900 level for me to take home about a 900 bucks.


So in a nutshell.

I sold an equidistant short strangle when market was at 6000.

Safe Range 5800-6200

Market moved up by 100 points to 6100.

I unwound my 6200 call at a 455 rupee loss and had 3 possibilities.

Sell a 6300 call. Safe Range 5800 - 6300. Covers my loss, and gives small profit.

Sell two OTM calls. Safe Range 5700-5800-6400. Does not completely cover my loss, increases margin requirement.

Sell a 5900 put. Safe Range 5800-5900 + Naked but, Market is in strong uptrend.

Ofcourse, I should be buying a bull spread or a ratio spread in an uptrending market, but I figure buying options is the lesser evil since my max loss will be known beforehand, but selling options requires a lot more management.

If I have made a laughably horrible miscalculation, please laugh at me, but do point it out. What are your thoughts on the short strangle and its management? How do you manage your positions?

Thank you for your time

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

Before i comment please answer the following questions?

1.What Software are you using for option related Calculations?

And what are the margin requirements of your broker?..

-Does he demands margin according to the Spreads Maximum Loss Risk
-Or like ~30K for naked 5800 put and ~30K for naked call

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

Hi sandeepnair

You get all my respect for such a post :thumb:

You wrote :

""Please note that this is a blind trade. There has been NO analysis of the market eod data BEFORE the trade. I will only be reacting to the market AFTER making my blind trade to enable me to take decisions ruthlessly if the market hits me hard. It will become more clear after the end of this trade that I post. At this point I am only looking at the mechanics of the option trade and not looking to predict the movement of the market. Keeping this in mind, even if it looks foolish that I am selling a strangle in a trending market, please bear with me and analyse my strategy. All trades are 1 lot.""

Some other points in advance, before you go in the market. Some are only details, but quit important when it comes to reality.

- How do you implement the strategy in the the market ? Do you want to leg in or do you want to place spread orders ?

- Do you want to give a market order or do you give a limit order ?

- What is the impact of the vola to any of your positions atm and otm ? Does it have any impact or is time decay more important ?
Be clear about that and be careful about that.

-You speak about a ratio spread in an uptrend. Call ratio spreads have an uncapped risk like short strangles.
Take the bull spread and if market runs against you convert the bull spread in to a butterfly. ( Sell the same strike level you sold in the credit spread again and buy, exactly with the same different you have in your credit spread between your strikes, one option on a strike, which covers this different, in the direction the market moves. You then have 1 long / 2 short / 1 long and this is in option language a butterfly )

I do not know, if your option market is so far developed, to trade so fine tuned strategies. So test it carefully !

-Sell a 5900 put. Safe Range 5800-5900 + Naked but, Market is in strong uptrend. Do not do such stuff ! You have already one naked put left in that situation and then you want to add more naked puts ! Never do that.

As my comments above are related to your wish to get answers to your paper trade, I will give you here an idea from my repertoire for choppy markets, as straddle and strangles are likely traded in such markets :

Buy a straddle. Market moves down and you get the signal for turn up. At this time, you sell a put. Market moves up and gives a sign for a pull back. You buy back the sold put. Market starts to go up again. You sell a put and so on. In that way, you make your profits with the traded option. ( You always keep the straddle, hope this was clear understood and beside the straddle you have, you trade one option in the choppy market. The straddle is your protection on your upper and under side of the market and between this range, you trade your option by selling and buying back this option. ) You have to test, if such strategy's are makable in your traded market.

Finally : In paper trades we can do what ever. At the moment, when we are in the market, we have to do what market tells us. Becoming a real good option trader, we test our ideas in advance on good analyzing software. We also have our adjustment plans by us, when we are in the market and this adjustment plans we also worked out on paper in advance. If you really like option trading, you are in my opinion on the right way.

You may like some stuff here : http://theaceprogram.com/NewTraders.html

Take care

DanPickUp

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

Post is updated, as it was very late yesterday when I was posting.

http://www.traderji.com/options/460...ng-strategy-long-post-warning.html#post479581

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

Hello rrrmanish, thank you for taking time out to go through my post.

I am using Options Oracle for tracking my positions.

As of now I haven't hired a broker. But a friend of mine has a local broker who charges, like you said, a fixed amount per naked position. That is like, you know, your-friendly-neighbourhood-broker-you-went-to-school-with kinda things. I don't have big volumes to offer him though.

I plan to go for a "conventional" broker soon and I am pretty sure they will be charging Spreads Max Loss Risk if what I have read from their documentation is correct. In which case a trading capital of 100000 wont do me any good I guess.

I am waiting for the customer care execs at Angel Broking, RK and Sharekhan to get in touch with me.

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

Hello DanPickUp, thank you for taking time out to go through my longish post.

I have benefited a lot from your comments, especially on that mega options thread, and thank you for that. I know you don't like spoonfeeding, and I am fine with that. Just point me out in the right direction and I will hack my way through the jungle

In fact, I first became aware of the Butterfly from your post and then learnt a bit about it. However, it didn't occur to me to use it to manage a strangle. Thank you for that tip. I will try a few paper trades in the next few weeks to test it out.

Bouncing around inside a bought straddle shouldn't be too hard and is a very intriguing idea. It might just make the amount of money blocked for margin lesser. I am a novice yet, and I am still getting my historical data for the markets in order (Amibroker) so I will have to test that out over the next couple of months and see where I go with it.

Your post is exactly why I asked for help. We novices feel like the king of the jungle when we make a simple strangle or bull spread trade. Then along comes someone managing a spread within a spread within a spread. Kinda like the movie Inception. Haha.

Also.

I enter market orders so that I don't manipulate my paper trade. I take what I get so that I learn to account for slippages in the beginning itself.

I plan to leg in.

Vola = Volatility I guess.

I read about a post where some guy bought options during the day the budget was to be declared (in India). The market did go as per his analysis, but since the volatility on the day he bought his options was so high, and since the volatility fell sharply after the budget, his options gave him a loss as the premiums went down sharply. So I guess volatility IS a factor.

I am still trying to collect figures for volatility for index options and some stock options I plan to trade. My plan is to compare the historical volatility and the last 1 month volatility to the current volatility of the market. If the volatility is high, I plan to sell options and take advantage of the premium erosion as the volatility falls, as well as the time decay.

I hope I am coherent in the post. Thank you for your time.

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

Hi sandeepnair

Hope you had a nice weekend.

First : You comment : ""In fact, I first became aware of the Butterfly from your post and then learnt a bit about it. However, it didn't occur to me to use it to manage a strangle""

Seems to me, that there was a misunderstanding on both sides of us, because I was not enough clear with my comments.

As you can trade an uptrend also with puts, we than would speak here about a bull put spread ( Credit put spread ) and not about a Bull call spread ( Debit call spread ).

This bull put spread you can convert in to a butterfly, in case the market goes / turns against you and not the bull call spread. As the bull call spread is made of an atm call and an otm call, you only would expand your range on the upper side and not on the under side and that is not, what is the idea behind such a strategy.

Example with the bull put spread ( Credit put spread ) :

Spot of underlying by 100.

You then short a 100 put and you go long a 90 put.

You are in the market, market moves up a certain way and now market starts to plump and to get choppy. You now can leave the market or you can add two legs by going short an other 100 put and going long a 110 put. You then have a butterfly, which should cover the choppy range.

The logic behind that : You can log in profit be selling the 100 strike again. As the price of the strike is even cheaper, as market is higher, you do not cash in, but you look the profit in between this two sold ones. The 110 put will cost some money and this money should come from the logged in profit of the two sold 100 strike prices.

As you did not enter the butterfly in one step, the analyze picture will be much better compare you would do it in one step. If the market is not to volatile, the range is no covered and you are covered.

( As always, test first such stuff on good software and only then, you may use it in your market and also test it on different times frames with different expiry dates of the option )

Second : Vola is Volatility and you have to be clear about that.

http://www.traderji.com/options/305...g-strategy-option-spreads-117.html#post462551 ( Volatility smile )

http://www.traderji.com/options/305...ng-strategy-option-spreads-98.html#post440798 ( Volatility and strategy / print this sheet and hang it in front of you, so you quickly see, what you have to go for )

http://www.traderji.com/options/305...ng-strategy-option-spreads-98.html#post440875 ( Straddle or strangle )

Take care

DanPickUp

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

@ sandeepnair,

For books on options try George Jabbour, Nassim Taleb, Charles Cottle.

To trade without bias read up on dynamic delta hedging. Cheers.

Trading a short strangle without a backup plan is nothing short of suicide IMO.

Re: Newbie seeking clarification on a short strangle trading strategy *long post warn

@DanP

Beautiful! I get it. Will run some trades with that.

Also, thanks for the links. I had been meaning to force myself to understand the volatility smile but was putting it off. Guess I will get to work

@Capricorn

Thank you for the suggestions. I will buy some of those authors.

I did read up a little on dynamic delta hedging, but not seriously. Since you recommend it I will get back to the nuts and bolts of that strategy again.

That suicide thing, yeah. But without newbs to slaughter, how would the market work.