Low Risk Options Trading Strategy - Option Spreads

[DanPickUp]

Hy

I have to

 

[lazytrader]

LT, After knowing in spreads, u might have other choice as well..i.e buy 2 atm spreads or 5 OTM spreads.

It is the topic of position sizing (many call it money mgmt, risk mgmt etc), which answers "how much ?" part of trading jigsaw. And many successful traders agree that they got the breakout in their trading results only after getting this piece right.

If I can put it in simple terms,
(a) Size of account = 100000
(b) You decide to put 5% of account size as a Max risk on 1 trade so Risk per trade = 5000.
(c) You also decide to not put more the 20% of your account in one single trade = 20000. That means u can 5 trades of 10k each.. but your stops will ensure that u don't loose more then 5k in each of them giving u max loss of 25k if all 4 go against you. (I am using these absurd ratio of 5 and 20 here as example. In real life, I will reduce to more reasonable limit)

Depending on trade you are selecting, you know your risk of that particular trade which is (entry price - stoploss price). In case of spread, or option trade, it can be the net premium that u pay but u
can decide on your stoploss limit and decide to take lower risk.
Say Your entry price 85, and stop as suggested by charts or your strategy is 65. So you are taking 20 pts risk.
Divide 5000/20 to get the position size = 250.. i.e.5 contracts (as 1 contract = 50 underlying of NIFTY). So as per point (b) above, you can buy 5 contracts.

As per point (c) above, in 20000, you can buy 20000/85 = 235 i.e. 4 contracts.
So you just go ahead with minimum of 5 or 4.. and stay within sensible trading boundries as you have defined for yourself.

If your risk turns out to be 80 rs.. then your position size will be = 5000/80 = 60 i.e 1 contract.as per point (b)

This is as simple as I can explain about Position sizing at level 0. As position moves in your favour, you risk starts turning into profit, and u might decide to add extra contract and still keep the
risk within 5k limit but enhance the profit potential..

Whether u buy ATM/ ITM/ OTM / Spreads has nothing to do with HOW MUCH part. Factors that decide selection of OTM /ATM depends on your view about the trend, trend strength so that OTM
has chance to become ITM, time left till expiry, distance of OTM from current spot level etc..
Once u have decided that you want to buy OTM or ITM, then come back to above calculation to decide on HOW MUCH.

Not the other way, where u decide to buy OTM cause they cost less and you can afford to buy more contracts there. Those OTM will loose fast and hit the 5k risk limit on very comparatively smaller adverse move.

Hope this helps.. (maybe you already know all this but atleast it can help others)

Happy Trading

I was talking more in terms of hedging for futures to cap the downside risk in case of overnight positions.

For eg, usually these days the range on nifty has shrunk considerably which makes it difficult to trade intraday and then next day it gaps up and has a small range again. just holding on to a posistion till the next day would give enough profits as trading intraday for 5hrs.

I usually have a opening bias based on previous days close so i was thinking that instead of closing a long position when there is a stong close I could keep it open and buy puts to limit downside risk.

Lets say nifty when trading in 47xx range moves up over 4800 intraday and holds 4800 on close then instead of closing the long position I could buy 4800 put to hedge it. I will buy the put 5 minutes before the close of trade and sell 5 minutes after open next day morning.

1- If nifty gaps up next day say 50pts then I gain 50 on future and lose lets say 25 on put assuming delta 0.5. I sell the put and hold the future and then it is trading futures as usual.

2- If it gaps down 50 then I lose 25 net. In such a case if feel there is further downside I sell the future hold the put.

Problem is in executing it...
1. Would theta/vega make a difference?
2. From what I have heard trading options early in the day may result in a bad fill which is going to eat into the profit on the future. If there are rapid moves at opening then limit order may not get filled and modifying the order and re-submitting can hurt more.

I have never tried trading options early in day, wanted to know if this will work and is there anything else I need to know?

 

[DanPickUp]

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[AW10]

LT, I see your point and 100% agree with this approach of hedging the open position for risk of gap open. (Infact, I use it when I turn my daytrade option position where stop is not hit during the day and I decide to convert into swing position). For this purpsoe, we have two choice, either buy Put or Sell Calls. Both are giving us protection against the fall.
As a option buyer, time decay is working against us. .but as a seller, it works for us.

I have not traded options in 1st hr.. but read from other traders that options are not fairly priced due to volatility of opening hrs. But in next 30m/60m everything settles downs to normal.
So I prefer to remove the hedge only after dust settles down i.e after 30m /60m or so.

Basically by using above appraoch you are reducing the delta of futures long position form +1 to +0.5 by buying ATM PUT which has delta of -0.5. You can very well use ITM / OTM strikes to
leave overnight delta at value other then +0.5 say ( +0.2 or +0.8 etc)

Would certainly like to know more about option premium in opening hrs, so pls share your experience, observations on this.

Happy Trading

 

[DanPickUp]

Deleted , sorry haven't read all the posts.

 

[DanPickUp]

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[DanPickUp]

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[lazytrader]

LT, I see your point and 100% agree with this approach of hedging the open position for risk of gap open. (Infact, I use it when I turn my daytrade option position where stop is not hit during the day and I decide to convert into swing position). For this purpsoe, we have two choice, either buy Put or Sell Calls. Both are giving us protection against the fall.
As a option buyer, time decay is working against us. .but as a seller, it works for us.

I have not traded options in 1st hr.. but read from other traders that options are not fairly priced due to volatility of opening hrs. But in next 30m/60m everything settles downs to normal.
So I prefer to remove the hedge only after dust settles down i.e after 30m /60m or so.

Basically by using above appraoch you are reducing the delta of futures long position form +1 to +0.5 by buying ATM PUT which has delta of -0.5. You can very well use ITM / OTM strikes to
leave overnight delta at value other then +0.5 say ( +0.2 or +0.8 etc)

Would certainly like to know more about option premium in opening hrs, so pls share your experience, observations on this.

Happy Trading

If you don't trade options early in the day then I won't try it. hehe

I guess watching levelII quotes can give us a fair idea

 

[AW10]

Yes DanPickUp. I use Synthetic Stocks (Long or Short) when want to take aggressive position.. That means, when I have more confidence in trend direction. Avoid using them when mkt is sideway, or trend is not very clear.

Many a time, I start the position straddle/strangle giving me mkt neutral start (specailly when playing breakout from consolidation) and then adjust it to make synthetic position on clear development of trend after breakout.

Synthetic Stock Long is = Buy CALL + Sell a PUT. Virtually, whole position needs if free of cost to initiate and hence Reward Risk ratio is high.. (almost infinite) cause u are getting return with 0 initial investment.

But, at the same time, if directional reading is wrong.. then it hurts equally fast cause both options will loose..

I think, what LT is talking about is hedging a Long futures position by Put. I don't know if there is equivalent Synthetic Strategy for this or not. Anyway, I am more concerned about what is my purpose, does the net position meets that purpose and what my risk graph and breakevens will look like, then knowing the right name of the strategy.

Do you trade Synthetics ?

Happy Trading

 

[AW10]

If you don't trade options early in the day then I won't try it. hehe

I guess watching levelII quotes can give us a fair idea

Not just watching Level II quote.. but interpreting them and making sense out of those changing numbers.

I know how many traders watch Level II screen but not able to go beyond that orderflow and understand the message coming out from there.

That is a skill which I want to develop. but keep giving myself excuse that it is only for scalper, not for me. Maybe someday I get over my lame excuse and spend time in understanding it.

By the way, do you know where can we get realtime Level II data for NIFTY Futures ?
I depend on orderbook screen of my brokers platform..
In my view, that does not give correct picture. It will not show the market orders that are getting filled at a moment cause they get filled before the screen is refreshed. If I place Trigger + Market order, it will never come on the orderbook but as soon as trigger is hit, it gets executed.
So you end up seeing only the limit orders of semi -professional daytraders.. not actual execution flow at exchange server.

Happy Trading.