Low Risk Options Trading Strategy - Option Spreads

[scorpio77]

HI LT / AW10,

Can you pls explain a little bit more about how to read open interest data? From experience I know that max open interest and a further gain at a strike is perceived to be a support / resistance. What is the reason?

Can you also tell us a little about the Put Call ratio data? How does one read an increase or decrease in this value?

Thank you for your efforts. Been learning a lot here.

Regards,

Scorpio

5000 PE adds 155% (2mil)
46,47,48,49,5000 CE shed 2millin in OI

5100 PE adds 370k in OI
5100 CE adds 260k in OI

5000+ expiry looks certain, 5100 is split down the middle - yesterday 5100 CE OI was 2mil and added 260k today but 5100 PE is OI build up is very rapid with 500% increase today adding 378k today. currently OI at 5100 PE - 500k

 

[lazytrader]

HI LT / AW10,

Can you pls explain a little bit more about how to read open interest data? From experience I know that max open interest and a further gain at a strike is perceived to be a support / resistance. What is the reason?

Can you also tell us a little about the Put Call ratio data? How does one read an increase or decrease in this value?

Thank you for your efforts. Been learning a lot here.

Regards,

Scorpio

http://www.optiontradingpedia.com/put_call_ratio.htm

Everything is well explained on this site. Check out the other pages as well. Handy as a quick reference when you come across something you don't remember or need confirmation or just plain new.

 

[scorpio77]

Hi LT,

Went through the site. Thank you! Although they have tried to explain in simple terms the summary seems to be that these indicators are inconclusive!

PCR is explained as a contrarian indicator which is not so reliable on index options as they tend to be skewed towards Puts. Even if we ignore this does the current high PCR mean that the market is due for a correction shortly?

On open interest, again the possibility of market manipulation by a group of traders to ensure max options expire worthless seems too hard to believe. The process would also be highly complicated considering that they may be holding positions in direct equity and futures as well!

Is this then speculative by nature? Pls explain.

http://www.optiontradingpedia.com/put_call_ratio.htm

Everything is well explained on this site. Check out the other pages as well. Handy as a quick reference when you come across something you don't remember or need confirmation or just plain new.

 

[AW10]

Hi,

Please confirm if below are the correct examples for Bear Spread & Bull Spread

Bull Spread:view is that market will remain above 4900
Buy 4700CE=357 (for Oct series - as of 18th Sept)
Sell 4900CE=227 (as of 18th Sept)
Net Cost=357-227=130
Max Risk=130 if expiry is below 4700.
Max Reward=200
Net profit = 200-130=70
BEP=4700+130+2=4832

Bull Spread:view is that market will remain above 5100
Buy 4900CE = 227
Sell 5100CE = 121
Net Cost= 94
BEP=4900+94+2=4996
Net Profit = 200-96=106

Bear Spread - view is that market will stay below 4900
Buy 4900PE - 136
Sell 4700PE - 75
Net cost = 61
Max Risk = 61
Reward=200
BEP=4900-61=4839+2=4841
Net Profit=200-61=139

Bear Spread - view is that market will stay below 5100
Buy 5100PE = 230
Sell 4900PE = 136
Max risk= 94
BEP=5100-94=5008
Net Profit=200-94=106

simu2004, the examples that u have given are correct bull/bear spreads.
By Definition,
Bear spread = buy HIGHER strike, sell LOWERstrike.
Bull spread = buy LOWER strike, sell HIGHER strike.

If yr view is that mkt will be above 4900, then many bull spreads can be created like - 4500/4600, 4500/4700, 4500/4800, 4600/4700, etc.. There is no limit to the combinations.

Similarly, you can create many bear spreads.. of 100 pts, 200 pts, 300 pts ranges.

Happy Trading

 

[AW10]

Scorpio,
IMO, PCR is just another way of reflecting OI data at a strike price.

I use PCR data (and few derivatives of them) just as one of the input in decision making while selecting particular option strike.

I chk PCR at each strike price, OI of PUTs and OI of CALLs at each strike price, PCR of all strike prices, and in last week of the month, USE OI of current month + next month in PCR calculation.

OI of PUTs indicates bullish sentiment of Market partcipants at that level. And OI number of CALLS indicate the bearish sentiment. That means, we can use this data to get rough idea about support (PUTs OI) and resistence (CALLs OI)

eg - if 4800 has Puts OI of 3 lacs, 4700 has PUTS OI of 2lacs and 4600 has PUS OI of 5 lacs. then more mkt participants have written 4800 put and hence they are bullish at this level. So 4800 shd act as first support. If this is broken, then next stronger support comes at 4600 cause 4700 PUTs are less in number hence less people are bullish at that level.
So lets say if I have to create spreads, or sell option, then I prefer to sell the strike which has higher OI.

PCR gives wrong info as we near the expiry cause contract gets closed in near month and new contracts are opened in Next month. So we have to be a bit careful while using these numbers.

As market moves in either direction, smart option traders keep shifting the position of their strikes as well (rolling up /down).

Hope this helps.

Happy Trading

 

[yogesh-tiwari]

Hi,

Please confirm if below are the correct examples for Bear Spread & Bull Spread

Bull Spread:view is that market will remain above 4900
Buy 4700CE=357 (for Oct series - as of 18th Sept)
Sell 4900CE=227 (as of 18th Sept)
Net Cost=357-227=130
Max Risk=130 if expiry is below 4700.
Max Reward=200
Net profit = 200-130=70
BEP=4700+130+2=4832

Bull Spread:view is that market will remain above 5100
Buy 4900CE = 227
Sell 5100CE = 121
Net Cost= 94
BEP=4900+94+2=4996
Net Profit = 200-96=106

Bear Spread - view is that market will stay below 4900
Buy 4900PE - 136
Sell 4700PE - 75
Net cost = 61
Max Risk = 61
Reward=200
BEP=4900-61=4839+2=4841
Net Profit=200-61=139

Bear Spread - view is that market will stay below 5100
Buy 5100PE = 230
Sell 4900PE = 136
Max risk= 94
BEP=5100-94=5008
Net Profit=200-94=106

AW01,

Correct me if I am wrong.

Though, you have given thumbs up to this post...I think bear spread is incorrect.

First case..unless market expires at/below 4700...Reward would not be 200.

Similarly, in case 2. unless market expires below 4900, there is no scope of getting 200 at expiry.

 

[adshanth]

Hy sameer999

I meant put back sprea

Dear All / AW10 / Lazytrader / DanPickUp

Thank you for this excellent thread, i was going through the same and it has definitely increased my knowledge

DanpickUp talks of Post 131 and a trading strategy / plan, but i cannot seam to find it, can somebody repost the same.

thank you

 

[lazytrader]

AW01,

Correct me if I am wrong.

Though, you have given thumbs up to this post...I think bear spread is incorrect.

First case..unless market expires at/below 4700...Reward would not be 200.

Similarly, in case 2. unless market expires below 4900, there is no scope of getting 200 at expiry.

They are alright. they are call spreads so if you buy the lower stike and sell higher then you make profit if expiry is above lower strike + net prem outflow. Max profit will be above higher strike where the profit from long call will cancel out loss from short call.

 

[lazytrader]

Hi LT,

Went through the site. Thank you! Although they have tried to explain in simple terms the summary seems to be that these indicators are inconclusive!

PCR is explained as a contrarian indicator which is not so reliable on index options as they tend to be skewed towards Puts. Even if we ignore this does the current high PCR mean that the market is due for a correction shortly?

On open interest, again the possibility of market manipulation by a group of traders to ensure max options expire worthless seems too hard to believe. The process would also be highly complicated considering that they may be holding positions in direct equity and futures as well!

Is this then speculative by nature? Pls explain.

In India at least PCR is not speculation. The markets are so heavily manipulated that even if it goes past the expiry price as per PCR it will come back by expiry day. :lol:

 

[yogesh-tiwari]

They are alright. they are call spreads so if you buy the lower stike and sell higher then you make profit if expiry is above lower strike + net prem outflow. Max profit will be above higher strike where the profit from long call will cancel out loss from short call.

Definitely in BULL spread, but what about the BEAR spread...in which this gentleman expects market to expire below 4900 (in BEAR speard case 1) and below 5100 (in BEAR spread case 2) for earning max profit.

If my understanding is correct then, unless market expires below lower strike price(as he is here buying/selling puts), he 'd not be able to make max profit.