Low Risk Options Trading Strategy - Option Spreads

[adshanth]

Thats exactly what this thread is all about.
By selling 4500 put, and buying 4700 put, u are creating a BEARISH PUT SPREAD.
This is bearish spread, You will have to pay money from your pocket cause 4700 put is costlier then 4500 put.. At today's closing price,
you will pay 195 to buy 4700 put, and you will get 100 for selling 4500 put.
Your net debit is 195 - 100 = 95 Rs,
If market falls and stays below 4500, you will make 200 rs of profit which is certainly good trade.. i..e risk 95 rs to make 200 Rs. in next 20 days.

to me, this certainly sounds attractive.

Happy Trading

Dear AW 10

"risk 95 rs to make 200 Rs in next 20 days"

Actually as per the above strategy Max Loss is 95 Rs, Max Profit is 105 (200 Rs profit - 95 Rs already paid for option) Rs, hence risk is 95 and return is 105 rs

Pls correct me if am wrong

Thanks

 

[terminator_123]

One difference I observed when trading ITM short strangle and OTM short strangle is the change in strangle value near boundaries(4500,4700 as in example given by AW10). As we near the boundaries, ITM strangle's value will raise slower than the OTM one. This is because both the legs are ITM and hence gain, loss is near equal. So we will have more time to make any adjustments to the spread.

 

[scorpio77]

HI AW10,

Can you suggest some spread where one buys both legs of Put or Call under the current situation? The margin required to sell Options is very high and hence the request.

Thats exactly what this thread is all about.
By selling 4500 put, and buying 4700 put, u are creating a BEARISH PUT SPREAD.
This is bearish spread, You will have to pay money from your pocket cause 4700 put is costlier then 4500 put.. At today's closing price,
you will pay 195 to buy 4700 put, and you will get 100 for selling 4500 put.
Your net debit is 195 - 100 = 95 Rs,
If market falls and stays below 4500, you will make 200 rs of profit which is certainly good trade.. i..e risk 95 rs to make 200 Rs. in next 20 days.

to me, this certainly sounds attractive.

Happy Trading

 

[lazytrader]

One difference I observed when trading ITM short strangle and OTM short strangle is the change in strangle value near boundaries(4500,4700 as in example given by AW10). As we near the boundaries, ITM strangle's value will raise slower than the OTM one. This is because both the legs are ITM and hence gain, loss is near equal. So we will have more time to make any adjustments to the spread.

ITM option value will raise slower because it already has a high value.
If you compare both legs or ITM and OTM options then vary almost equally. as long as the underlying is equividistant from the strikes.

Were you talking about something else?

 

[lazytrader]

Lets me compare these 2 strategies to see the difference and similarities..

1, Short Strangle = Mkt being at 4600, sell 4500 PUT and 4700 CALL.. Both are OTM.
At todays closing price you get 100 for 4500 PUT and 113 for 4700 CALL.
Amount Received = 100+113 = 213
Lower Break-even points = 4500 - 213 = 4287
Higher BE point = 4700 + 213 = 4913.
i.e. when mkt is between 4287 and 4500, you will be in profit but less then Max profit ie. 213
Similarly, when mkt is between 4700 and 4913, you profit will be less then max profit ie.213
When market expires between 4500 and 4700, you keep the whole premium of 213.

Beyond, 4913 and 4287, risk is unlimited.

2, Reverse Short Strangle (I am giving this name cause I don't know the exact name for this strategy)
= Mkt being at 4600, sell 4700 PUT and 4500 CALL.. Both are ITM.
At todays closing price you get 217 for 4500 CALL and 195 for 4700 PUT.
Amount Received = 217+195 = 412 (when market expires between 4500 and 4700).
Guaranteed value of this spread = 200
so net credit on expiry = 412 - 200 = 212.. (which is no different from 1st strategy)

Don't think that in this case your break-even points will be 4500 - 412 = 4088 and 4700+412 = 5112.
BE points will be 4700- 412 = 4288 and 4500 + 412 = 4912. (almost same as strategy 1 )

Say when mkt is at 4300 on expiry, 4500 call is worth 0 but 4700 put is worth 400 rs now. so on settlement you have to
give back 0+400 = 400 rs..from 412 that was collected earlier. Giving u net profit of only 12 rs.

in first case, mkt being at 4300, 4500 put will be worth 200, and 4700 call is worth 0.
so you give back 0+200 =200 from 213 collected.. giving u profit of 13 rs.

So finally, there is no difference in both strategy from Reward / max risk / break-even / risk profiles.
The difference comes from
- brokerage (and hence stt, tax etc) - which will be high in 2nd case cause it is calculated as % of premium amount
- Margin requirement will be high in 2nd case cause due to ITM option, M2M variation will be much higher.

These are some of my observations. I was also attracted by strategy 2 and executed the trade.
But later I realised that due to brokerage and margin probably it is better to stick to simple short strangle.

Happy Trading

I think with the ITM variation there is net inflow when you open the position. Any idea how much?

 

[AW10]

Dear AW 10

"risk 95 rs to make 200 Rs in next 20 days"

Actually as per the above strategy Max Loss is 95 Rs, Max Profit is 105 (200 Rs profit - 95 Rs already paid for option) Rs, hence risk is 95 and return is 105 rs

Pls correct me if am wrong

Thanks

You are right. Risk 95 to gain net profit of 105.
In stock traders terminology, buy a stock at 95 and sell at 200..

Happy Trading

 

[terminator_123]

ITM option value will raise slower because it already has a high value.
If you compare both legs or ITM and OTM options then vary almost equally. as long as the underlying is equividistant from the strikes.

Were you talking about something else?

I was talking about the behavior near strangle boundaries. The delta of ITM options will be ~ 1. While the delta of OTM options will be less. As the underlying moves to one side, the increasing delta of losing leg coupled with decreasing delta of winning leg results in OTM strangle value raising faster than ITM strangle value at the edges.

 

[AW10]

HI AW10,

Can you suggest some spread where one buys both legs of Put or Call under the current situation? The margin required to sell Options is very high and hence the request.

Scorpio, Spread strategy, by definition involves selling 1 instrument and buying another instrument. If you are buying 2 puts or 2 calls then u are basically adding on to your original position created with 1st Put/Call. This approach is sensible only when u want to take aggressive position on a trend.

If you are buying 1 call and 1 put, it is not spread but creating direction neutral Long position. You can very well create this position with strike near the boundry of current consolidation i.e. 4550 / 4650 or 4500/4600 level. That means, buy slightly OTM Put/ Call. Expecatation is, when market breaks out of this range in one direction, u can either close the lossing leg and continue with winning leg. Or close both the legs asap the big breakout looses the momentum.

The strategy is called Long Strangle, just in case u want to read more about it.

Happy Trading

 

[AW10]

ITM option value will raise slower because it already has a high value.
If you compare both legs or ITM and OTM options then vary almost equally. as long as the underlying is equividistant from the strikes.

Were you talking about something else?

No LT, contrary to your argument, ITM options have higher Delta then ATM or OTM options hence, their value will change at higher pace then ATM/OTM options. eg - ITM with delta 0.8 will loose/gain 80 paise for each point move in nifty whereas ATM option with delta 0.50 will loose/gain on 50 paise or OTM option with delta 0.4 will loose/gain 40 paise for each point move.

You are right, if both the legs are equidistant from current spot, then their greek values and hence their movement should remain same.

The difference comes as SPOT moves further, the ITM options' delta can max go to max value of 1. That means,
ITM option has limited room to gain and more room to loose (in above example gain 0.2 delta and loose 0.8 delta) wheres
OTM option has more room to gain and less room to loose (in above example gain 0.6 and loss of 0.4).

Hope this doesn't confuse u but makes u think.
Happy Trading

 

[AW10]

I think with the ITM variation there is net inflow when you open the position. Any idea how much?

In ITM short strangle, you do gain 412 rs.. but it is guranteed that u will be giving back 200 of this on expiry day or whenever u close the position.
Whereas with OTM short strangle, though u get only 213 rs. but there is chance that u don't have to give back anything (if spot expires between your strike range)..

So from net cash flow over the period till expiry, there is no difference.
But Brokerage / Magin requirement makes the difference.

Happy Trading