Low Risk Options Trading Strategy - Option Spreads

[arnav_rulz]

I got a bit more clarity now about my previous doubt regarding which of the two strategies is better..

1)selling 5000 Call & buying 5100 Call
2)buying 5000 Put & selling 4900

Well except for the risk reward ratio of the two strategies (which you made very very very clear) & Pro's and Con's of these two strategies (which again you told us).. I think i have found another relation between the 2 strategies which makes it very easy to relate them to each other.

Actually both the strategies and quiet similar only.. Actually they are exactly the same. Except for the fact that both have different strike prices !!

Actually if you see..
Selling a 5000 call and buying a 5100 Call Is Exactly Equivalent to Buying a 5100 Put and selling a 5000 Put.
Both the strategies are exactly same and have the same outcome in every situation.

So the Difference in the 2 strategies i asked you was nothing but a difference of strike prices !! LOL

 

[AW10]

Arnav, the nature of spreads depends on buy strike and sell strike. it doesn't matter whether we use PUT or CALL.

Bullish spread = buyer lower strike and sell higher strike..
Bearish spread = Buy higer strike and sell lower strike.

At first glance they look same, but let me list the following differences

Debit spreads
- you are buying high premium option and selling low premium option hence
- you pay to mkt to open a position
- needs less margin
- needs underlying to move in the directionm and that too as soon as possible
- Negative Theta strategy, i.e. time has -ive impact on this spread. Hence if underlying stays in a range, it starts loosing .
- bullish debit spreads are created using CALLs,
- bearish debit spreads are created using PUTs

Credit spreads
- you are selling high premium option and buying low premium option hence
- it puts money in your account
- needs higher margin
- Positive theta strategy i.e. profits from time decay as well
- profits even when underlying stays in range
- Integral part of income generation strategies thru options
- bullish Credit spreads are created using PUTs,
- bearish Credit spreads are created using CALLs

Hope this gives new perspective to spreads..

Happy Trading

 

[arnav_rulz]

See thats what i want to say.. At first glance they look different, because of the different things done in the two strategies.. But Actually they are entirely the same (except for the margin required and money collected..)

Lets take an example.

Nifty currently @ 4750

Sell 4700 call @ 183
Buy 4800 call @ 128
(55) credit

Buy 4800 Put @ 147
Sell 4700 Put @ 102
(45) Debit

Lets make another strategy with strikes a lil far away from each other

Buy 5000 Call @ 52
Sell 4700 Call @ 182
(130) credit

Buy 5000 Put @ 270
Sell 4700 Put @ 100
(170) debit

Now.. Lets do one thing.. At this different point time and at different rates of nifty.. We would check how the two strategies are doing..
And i bet where ever the market is.. you would always find both the strategies are giving you the EXACT profit or loss ALWAYS. (except a diff of 2-3 points at most due to the trading diff..)

I think My point can actually be proven Mathematically also. I will figure out an equation or two when i get time..



Also You said..

Debit spreads

- needs underlying to move in the directionm and that too as soon as possible
- Negative Theta strategy, i.e. time has -ive impact on this spread. Hence if underlying stays in a range, it starts loosing .
- bullish debit spreads are created using CALLs,
- bearish debit spreads are created using PUTs

Credit spreads

- Positive theta strategy i.e. profits from time decay as well
- profits even when underlying stays in range
- Integral part of income generation strategies thru options
- bullish Credit spreads are created using PUTs,
- bearish Credit spreads are created using CALLs

Well i dont completely agree with it.. It may completely be opposite depending on the strike prices of our spread.

For Eg.. With Nifty @ 4750

Buying a 5000 Put @ 270 and selling a 4700 Put @ 100 Is a Debit strategy BUT In this case Time has a +ve impact on the spread i.e we gain if the Underlying Nifty stays were it is.

Similarly you can see what would happen if we Sell deep in the money call and buy OTM call, which is a Credit spread but time has a -ve impact on this strategy.


*Well all this is as per my understanding.. Hopefully what im saying is correct or i am atleast making a useful discussion and not wasting your time for no reason.

 

[AW10]

Arnav,

I am ok with proposal of tracking 4 spreads to get more insight into them. Lets collect 4/5 data points in next 2/3 weeks to make some observations on this.

In simple terms, I looked at Credit strategy as selling options.. i.e. the factors that works for selling option, shd work for any other credit position as well.
That was the reason for me to mention that Credit spreads have time advantage.

Any debit strategy is like buying option.. hence carry the shortcoming of long option position.

Lets track these 4 strategies over a period of time and see what comes out.. Hopefully we will agree with each other then.

Happy Trading.

 

[arnav_rulz]

See thats what i want to say.. At first glance they look different, because of the different things done in the two strategies.. But Actually they are entirely the same (except for the margin required and money collected..)

I think My point can actually be proven Mathematically also. I will figure out an equation or two when i get time..

Ohk tell me elaborate a bit more on this with a maths equation.. See..

Buying a Future(Y price) + selling a Call(X strike price) = Selling a Put(of X strike Price)
Selling a Future(Y price) + Buying a Call(X strike price) = Buying a Put(of X strike Price)

(For more info on the above equation http://www.traderji.com/technical-a...ractised-nifty-futures-trading-thread-13.html)

If assuming the above equations are correct(which they are.. which one can figure out if they read the above mentioned page..)

Selling a Call(4700 strike price) = Selling a Future(Y price) + Selling a Put(of 4700 strike Price) ----> Eq 1
Buying a Call(4800 strike price) = Buying a Future(Y price) + Buying a Put(4800 strike Price)----> Eq 2

Add Eq1 & Eq2 We get

selling a 4700 call + buying a 4800 call = buying a future + selling a future (both a price y i.e same price) + selling a 4700 Put + buying a 4800 Put

buying and selling of future gets cancelled.. So Simply put..

Selling a 4700 call + Buying a 4800 call = Selling a 4700 Put + Buying a 4800 Put

 

[arnav_rulz]

In simple terms, I looked at Credit strategy as selling options.. i.e. the factors that works for selling option, shd work for any other credit position as well.
That was the reason for me to mention that Credit spreads have time advantage.

Any debit strategy is like buying option.. hence carry the shortcoming of long option position.

See the thing is.. Normally In a credit strategy.. We receive more premium in selling one option than buying the other option. Therefore as time factor works for us..

But the Premium We receive are also of 2 types..
1)In the money part of the premium.
2)Out the money part of the premium.

Time decay only has an effect on Out of the money part of the premium.

Therefore all those credit strategies where OTM part of premium received is more than OTM part of the premium paid.. in all those cases time factor will work for us.. else vice versa

Lets the case i gave you previous as an example..

Nifty Nov futures is @ 4780

We buy a 5000 Put @ 270
Now the 270 we received as premium has two parts
a)In the money premium = 5000-4780 = 220
b)Out of the money premium = 270-220 = 50

and selling a 4700 Put @ 100 the whole of which is OTM premium.

So Since In this Debit Spread, the OTM portion of Put sold is less than the OTM portion of the Put brought.. Time decay would have a +ve impact.

We can see this as.. Currently we give 270-100 = 170 for taking the spread. And if say Nifty closes at the same level @ expiry (ie total time decay..)
We would receive 5000-4870 = 220
That is we gain 50 points due to time decay in a debit spread

cheers

 

[terminator_123]

See the thing is.. Normally In a credit strategy.. We receive more premium in selling one option than buying the other option. Therefore as time factor works for us..

But the Premium We receive are also of 2 types..
1)In the money part of the premium.
2)Out the money part of the premium.
....
cheers

In other words premium of all ITM options are made up of intrinsic, time values

 

[AW10]

In other words premium of all ITM options are made up of intrinsic, time values

Thats right. .And OTM or ATM option's premium has only time value .
Their intrinsic value is ZERO.

 

[AW10]

Ohk tell me elaborate a bit more on this with a maths equation.. See..
..........
.........

Thanks Arnav for beautifully explaining this equation. You are absolutely right with it and I agree with you.

Buying a Future(Y price) + selling a Call(X strike price) = Selling a Put(of X strike Price)

This is LHS of this equation is covered call strategy. Most of conservative investor use this strategy. But they will get a shock of their life, if they see the RHS and know that what they are doing is opening a naked short PUT position. (I also got shock when I came to know about synthetics)

Selling a 4700 call + Buying a 4800 call = Selling a 4700 Put + Buying a 4800 Put

I agree that at expiry both the strategies are equal..

Time decay, Volatlity, margin requirement, sensitivity of premium to the move of underlying etc comes in effect during the life of the strategy from now till expiry.
I was trying to address those points when I highlighted the difference between Dr./Cr. strategies.

I am working on putting a comparision table for this. Will post it soon.

Happy Trading.

 

[arnav_rulz]

I agree that at expiry both the strategies are equal..

Time decay, comes in effect during the life of the strategy from now till expiry.
I was trying to address those points when I highlighted the difference between Dr./Cr. strategies.

I am working on putting a comparision table for this. Will post it soon.

Happy Trading.

Nope, Both the strategies are the same all the time, not just at expiry.. I cant comment in relation to margin, but yeah for the rest of stuff...

Let take an example of Time decay.

Now we had established that.. it is only the OTM part of the option premium that has a time value effect and not the intrinsic part.

So.. for Both the strategies to have the same effect of Time decay.. Both of the strategies should have the same OTM premium ? Hmm lets case a few cases and check what we get..


NIFTY FUTURES = 4695

Example 1

Strategy I - Credit strategy.

Sell nifty 4700 Call @ 132 & Buy nifty 4800 Call @ 85
Both the premiums are OTM.. And their difference = 47 ie the total OTM we have received.

Strategy 2 - Debit strategy

Buy nifty 4800 Put @ 191 & Sell Nifty 4700 Put @ 138
OTM premium of 4800 Put = 191-105(4800-4695) = 86
OTM premium of 4700 Put = 138 -5 (4700-4695) = 133

Difference btw the OTM premium received = 47 i.e the same as above.

Therefore Both the strategies have the same time effect.


Lets take another Example.. This time of strike prices far away.

Example 2

Strategy 1 - Credit strategy

Sell 4600 call @ 189 & Buy 4900 Call @ 54
4600 call OTM premium received = 189-95 = 94
4900 call OTM premium paid = 54
Difference received = 40

Strategy 2 - Debit strategy

Buy 4900 Put @ 258 & Sell 4600 Put @ 96
4900 Put OTM premium paid = 258-205 = 53
4600 Put OTM premium received = 96
Difference = 43 received

So the difference in the OTM premium received btw the 2 strategies is just 3 points which is mainly just a trading fluctuation..

And it will be great if you can post a comparison table.. It will shed more light into this and maybe bring out newer things and theories.. After all Options are much much wider than we know and there is always scope to learn more.