Options - My way of looking at it

[pratapvb]

it is said that most option buyers suffer as most bought option expiry worthless. I would think that this is more applicable if you are buying OTM options.....plain buying of OTM options is to be done more for insurance

if you have a trend trading system, the ITM option give you a good advantage to trade positional....how? why?

if we trade postional with futures we have the following to consider
1. delta of futures is always 1 (both ways)
2. overnight risk of move against futures is high
3. if circuit is hit against us, then we are not in a position to do anything about it...cannot protect it or limit the loss etc

so how does ITM option help? details in next post

 

[pratapvb]

now lets see whether the option understanding (as summarized in prev page) helps us

lets say we have a buy signal in NF at 6230 and the 6100 NF Call is trading at around 170

intrisic in this is 130....so intrinsic to total is 0.76 for this ITM option....which will give us a rough delta of more than 0.8

I use ITMs which have a ratio of intrinsic : total of 0.7-0.8 to take the entry

ok now lets see how this helps

Move in Favour

1. Our call has a delta of 0.8+ and as it gets more ITM it will get closer 1....so though it won't gives us 100% of the move as future would, it would gives us most of the move

2. lets say it moves 100pts in favour...now 6200 call would be around 170 (assuming no time has elapsed and other factors remain same) and 6100 CE price would be 230 (intrinsic) + premium (which say is 30)...so 260. so now we book our 6100 CE and buy 6200 CE....effectively we have booked 90pts and remain in trend with approximately the same initial risk

so definitely an advantage for moves in favour.....now we need to analyze the advantages of move against

 

[pratapvb]

holding ITM in trend
Move Against

what if we have a move against? lets look at gaps for this, as otherwise intraday we are managing our trailing SL anyway

1. if it is a moderate gap against, then note that our ITM option becomes more ATM and so delta reduces and becomes closer to 0.5.....so the loss due to gap will be less compared to if we were holding futues (which has a delta of 1)

2. if HUGH gap against say of 300pts or even a circuit gap of 600+ in NF, then no issues as our loss is limited to the 170 we payed for the option....and in fact if we had got a chance to shift it once also ...the loss will only be 170-90 = 80 and if we had shifted twice (200pt move in favour) before this HUGE gap against, then no loss....whereas in future HUGH loss will be there

so all told a win-win situation for us

 

[jamit_05]

When the move is in favour, then where futures would gain 100 points against 100 points move of the underlying, the option would gain only 70.

If one were trading a system with positive expectancy, the this is a major disadvantage.

 

[pratapvb]

When the move is in favour, then where futures would gain 100 points against 100 points move of the underlying, the option would gain only 70.

If one were trading a system with positive expectancy, the this is a major disadvantage.

delta is 0.8+ so we would be gaining more than 80pts....and I am willing to forego that 10-20 pts...for the protection it gives me for move against, so that I can be positional and get good sleep and don't have to wake up in the middle of the night to see what dow jones is doing...and then not sleep rest of the night if dow jones is 3% against our postiion.....finally it is left to individuals

 

[pratapvb]

Trading the view using options

Hopefully these views are there due to a technical reason and not due to some hope or other factors. Given that let us see what we can do with options

potential sideways for next few days

Let us say that our view is that NF will not go much above 6600 (max Call OI is also there) and will not go below 6400 (maxpain is there)

so if NF is going to be in this 200pt range for the next few days can we take a position and benefit from time decay

maximum premium (more the premium more there is to decay) is for ATM option so we see both a Put and a Call of 6500

6500 PE sold at 59
6500 CE sold at 123
total credit 182
so we are safe 6500 +/- 182 but beyond that we will start making loss

now to protect the downside we need to buy insurances so we buy
6400 PE at 33 and
6700 CE at 33
net credit now 182-66 = 116

so what is our payoff at diff levels now?

at expiry, it will be something like this

if option trading it is important to know who to get this diagram...so that we know at what level our losses kick in and if there is a trend before that to take suitable corrective action

How to get this diagram in a simple way....will come to that

 

[DSM]

Thanks Pratap for your beautiful thread. You have taken a lot of trouble to put forth ideas in a clear and logical manner so that everybody can follow. Going thru your thread for me is revisiting what I had learnt in the past and forgotten or kept ideas unused. Am sure there will be many traders like me who will benefit from your post. 5 stars for from me for your thread.

Trading the view using options

Hopefully these views are there due to a technical reason and not due to some hope or other factors. Given that let us see what we can do with options

potential sideways for next few days

Let us say that our view is that NF will not go much above 6600 (max Call OI is also there) and will not go below 6400 (maxpain is there)

so if NF is going to be in this 200pt range for the next few days can we take a position and benefit from time decay

maximum premium (more the premium more there is to decay) is for ATM option so we see both a Put and a Call of 6500

6500 PE sold at 59
6500 CE sold at 123
total credit 182
so we are safe 6500 +/- 182 but beyond that we will start making loss

now to protect the downside we need to buy insurances so we buy
6400 PE at 33 and
66700 PE at 33
net credit now 182-66 = 116

so what is our payoff at diff levels now?

at expiry, it will be something like this

if option trading it is important to know who to get this diagram...so that we know at what level our losses kick in and if there is a trend before that to take suitable corrective action

How to get this diagram in a simple way....will come to that

 

[pratapvb]

so what is the best way to create the payoff diagram

you can of course use complex s/w etc...but it is good to have an understanding so that you can make a quick calculation

The simplest way is to find the payoff at each strike that is part of your strategy and one above and one below...and then connect them all as linear segments....that is it

taking our previous straddle example
remember we have a credit of 116

now we need to find the payoffs at
6300
6400
6500
6700 and
6800

6300.....100pt profit from 6400 bought PE, 200pt loss from 6500 sold PE and nothing from the calls....so +100 - 200 +116 (initial credit) = 16
6400.....0pt profit from 6400 bought PE, 100pt loss from 6500 sold PE and nothing from the calls....so +0 - 100 +116 (initial credit) = 16
6500 .....all 0 + 116 = 116
6700.....200pt loss from 6500 sold CE, 0pt from 6700 bought CE and nothing from
the puts so - 200 + 0 +116 (initial credit) = -84
6800.....3000pt loss from 6500 sold CE, 100pt profit from 6700 bought CE and nothing from the puts so - 300 + 100 +116 (initial credit) = -84

so we have
6300 16
6400 16
6500 116
6700 -84
6800 -84

now just connect this as linear segements and extent the outer edges to infinity on both sides and you have your payoff diagram

 

[manishchan]

Brother.. looks like some typo.. please clarify if that is 6700 CE because the price will be much higher than 33 for PE at the current level

Trading the view using options

Hopefully these views are there due to a technical reason and not due to some hope or other factors. Given that let us see what we can do with options

potential sideways for next few days

Let us say that our view is that NF will not go much above 6600 (max Call OI is also there) and will not go below 6400 (maxpain is there)

so if NF is going to be in this 200pt range for the next few days can we take a position and benefit from time decay

maximum premium (more the premium more there is to decay) is for ATM option so we see both a Put and a Call of 6500

6500 PE sold at 59
6500 CE sold at 123
total credit 182
so we are safe 6500 +/- 182 but beyond that we will start making loss

now to protect the downside we need to buy insurances so we buy
6400 PE at 33 and
66700 PE at 33
net credit now 182-66 = 116

so what is our payoff at diff levels now?

at expiry, it will be something like this

if option trading it is important to know who to get this diagram...so that we know at what level our losses kick in and if there is a trend before that to take suitable corrective action

How to get this diagram in a simple way....will come to that

 

[pratapvb]

Brother.. looks like some typo.. please clarify if that is 6700 CE because the price will be much higher than 33 for PE at the current level

Thanks

yes it is 6700CE bought as issurance to cap losses on up side