Since we're both Buying and Selling Calls, the Delta and Vega risks are reduced.
There are two reasons you need to consider before appreciating the benefits of this method:
1. Direction of a Stock: 70% of the time a stock either plummets or stays flat. It takes lot of effort for a stock price to move up. On the contrary, stock price falls faster than going up because of mass panic. Statistically, direction-wise, staying Short is more profitable. Having this said, I am not saying one cannot make money by Investing, its just that the other side is much more probable provided one respects the rules of the game.
2. Option Writing: Options are depreciating assets, so, Theta Decay is highly lucrative but that comes-in with many Risks and Uncertainties. First and foremost, Vega can be your friend or foe depending on the Implied Volatility (IV) and the price direction of the underlying.
Now since we are holding a bearish view on the stock (in this strategy) by selling far OTM calls, direction-wise, we do not want +ve Delta increase. Also it will be an insult to our injury when Delta increases accompanied by Vega rise (in other words, Stock price goes up rapidly). In this scenario, we want Vega to increase (if not staying flat) at Delta decrease, but not the other way round. Clearly, we can see that the "Rate of Change of Delta" (otherwise called Gamma) comes into the picture which solely determines whether to adjust or do nothing.
When we sell far OTM options IV plays the most crucial role. If you sit down with Black-Scholes model for some time you will see mathematical formulas showing that Gamma and Vega are two sides of the same coin of IV.
As individual participants, we can never control the market dynamics. So, if somehow we neutralize or reduce the Gamma effect, by default Delta and Vega risks are taken care. This bit is achieved by the "Bull Call Spread". Then we try to capitalize on Theta decay of far OTM Calls.
So, there are few rules for this strategy:
1. Avoid volatile stocks;
2. Avoid Earnings, Announcements, Result Stocks;
3. Avoid stocks that have history of going up by more than 10% in a month;
4. Follow stocks in Downtrend only (price trading below 50 MA);
5. Far OTM Strike must be above a strong resistance level (preferably from Monthly/Yearly timeframes);
6. While taking the position, far OTM Strike must be more or less at a distance of 10% from ATM Strike;
7. The position while acquiring must give +ve credit;
8. No adjustments to be made in the initial Bull-Call Spread;
9. Adjust far OTM strikes whenever required (we have already discussed in-depth how and when to adjust);
10. Do not apply this strategy in Indices.
Yes.
I am glad that you asking these questions, because without the understanding of the core-concept, execution becomes a far-fetched goal. In a nutshell, the idea is to reduce or neutralize Gamma risk and enjoy Theta decay. The Bull-Call Spread plays the most significant role in this strategy and makes all the difference when compared to naked option writing or Short-Strangles. For months at a stretch I have contemplated, experimented, studied, sacrificed my social-family life on how to reduce risk on naked option writing or Short-Strangles and haven't found anything better.
Let us take an example:
VEDL Chart
View attachment 32233
As you can see if VEDL falls and stays below 200 we make Rs.9315 at expiry. If it stays between 200 and 215.60, we make maximum profit of Rs. 16,215. There is another 2L kept secured for this position to counter adjustments (if prices comes to 215-218) on top of the Total Margin required. So, easily we can make 2-3 adjustments, if VEDL starts for a rally and still come-out profitable fearlessly.
There are two reasons you need to consider before appreciating the benefits of this method:
1. Direction of a Stock: 70% of the time a stock either plummets or stays flat. It takes lot of effort for a stock price to move up. On the contrary, stock price falls faster than going up because of mass panic. Statistically, direction-wise, staying Short is more profitable. Having this said, I am not saying one cannot make money by Investing, its just that the other side is much more probable provided one respects the rules of the game.
2. Option Writing: Options are depreciating assets, so, Theta Decay is highly lucrative but that comes-in with many Risks and Uncertainties. First and foremost, Vega can be your friend or foe depending on the Implied Volatility (IV) and the price direction of the underlying.
Now since we are holding a bearish view on the stock (in this strategy) by selling far OTM calls, direction-wise, we do not want +ve Delta increase. Also it will be an insult to our injury when Delta increases accompanied by Vega rise (in other words, Stock price goes up rapidly). In this scenario, we want Vega to increase (if not staying flat) at Delta decrease, but not the other way round. Clearly, we can see that the "Rate of Change of Delta" (otherwise called Gamma) comes into the picture which solely determines whether to adjust or do nothing.
When we sell far OTM options IV plays the most crucial role. If you sit down with Black-Scholes model for some time you will see mathematical formulas showing that Gamma and Vega are two sides of the same coin of IV.
As individual participants, we can never control the market dynamics. So, if somehow we neutralize or reduce the Gamma effect, by default Delta and Vega risks are taken care. This bit is achieved by the "Bull Call Spread". Then we try to capitalize on Theta decay of far OTM Calls.
So, there are few rules for this strategy:
1. Avoid volatile stocks;
2. Avoid Earnings, Announcements, Result Stocks;
3. Avoid stocks that have history of going up by more than 10% in a month;
4. Follow stocks in Downtrend only (price trading below 50 MA);
5. Far OTM Strike must be above a strong resistance level (preferably from Monthly/Yearly timeframes);
6. While taking the position, far OTM Strike must be more or less at a distance of 10% from ATM Strike;
7. The position while acquiring must give +ve credit;
8. No adjustments to be made in the initial Bull-Call Spread;
9. Adjust far OTM strikes whenever required (we have already discussed in-depth how and when to adjust);
10. Do not apply this strategy in Indices.
Yes.
I am glad that you asking these questions, because without the understanding of the core-concept, execution becomes a far-fetched goal. In a nutshell, the idea is to reduce or neutralize Gamma risk and enjoy Theta decay. The Bull-Call Spread plays the most significant role in this strategy and makes all the difference when compared to naked option writing or Short-Strangles. For months at a stretch I have contemplated, experimented, studied, sacrificed my social-family life on how to reduce risk on naked option writing or Short-Strangles and haven't found anything better.
Let us take an example:
VEDL Chart
View attachment 32233
As you can see if VEDL falls and stays below 200 we make Rs.9315 at expiry. If it stays between 200 and 215.60, we make maximum profit of Rs. 16,215. There is another 2L kept secured for this position to counter adjustments (if prices comes to 215-218) on top of the Total Margin required. So, easily we can make 2-3 adjustments, if VEDL starts for a rally and still come-out profitable fearlessly.
