Option Strategy March 2010

It is time to implement our strategy for this month. Our decision to wait till the budget event to get over has really paid well. Now the market is at least 5% above the budget levels.

Before discussing this month strategy here is my post which describes our option strategy

This month I am following a staggered approach when you will only sell options which are worth half of your margin money. Since I am slightly bullish on the market I expect to sell rest of the options as the market goes up from here.

Sell the following call options

March 5200 Call Option at 50Rs – 6x lots


March 5300 call Option at 19Rs – 4x lots (this is optional I had some margin left so I sold this one)

April 5300 Call Option at 74Rs – 6x lots

April 5400 call Option at 45Rs – 10x lots

May 5100 Call Option at 210Rs – 2x Lots

This time the premium is slightly low as most of the market men expect a correction (which is another reason why the market goes up)
 
Tomorrow if the market is up then i plan to deploy another 20% of the margin money by selling higher call options. however if the market goes down then i would wait and just watch these options decay :-)
 

Option Strategy Follow-up (Feb -22)

This is the follow-up of the strategy discussed here.(Maximize Your Returns using Options)
On Jan 29 I have these options in my hand (See the post on Jan 29 here)

4600 Put option at a premium of 70Rs (x number) (breakeven 4530)
4500 Put option at a premium of 35Rs (5x number)(breakeven 4465)
4400 Put option at a premium of 23Rs (10x number)(breakeven 4377)

The current value of these options are given as under

25th Feb is the expiry date of all these options and I expect all these options to expire unexercised (i.e. reach the value of zero). Nifty current value is 4856.

What is the strategy for this month?

Option Strategy Follow up (Jan 29 2010)

This is the follow-up of the options strategy discussed here.
This month was like a feast for option sellers if someone has followed the strategy discussed earlier.

During the first week of January when the market was touching 5300 I sold the following call options of February
5700 Call option at a premium of 28 Rs (20x number of options)
5600 Call option at a premium of 45Rs (15x number of options)
5400 Call option at a premium of 79Rs (3x number of options)5200 Call option at a premium of 210Rs (x number of options).

The x in brackets is the distribution of options I have sold. I have given this to demonstrate how you can change your risk profile and return ratio.

Here the 5200 option carries the maximum risk, and that’s the reason why I got maximum premium for that. As I mentioned that I am a medium risk taker this market from my point of view has gone up far ahead of its fundamentals in the short-term. This is the reason I want to capitalize on any short term aberrations in valuations. My breakeven point for this option is 5410. This means if the market were to go up above 5410 on a closing base on Feb 25th I will have loss in the 5200 call option selling.

To mitigate this I sold higher out of the money call options of 5400 (break even at 5479), 5600 call option (breakeven 5645) and 5700(break even 5728). Also I sold more of 5700 call options since it carries less risk.

All these options have been sold around Jan 1st week and second week with an expiry of Feb 25. Now after the crash all these options are reduced to a minimum because of the time decay and the adverse market conditions.

Given below is the current value of all these options.

5700 Call option – 2.5 Rs
5600 Call option – 3.45Rs
5400 Call option – 7.90Rs
5200 Call option - 26Rs

Given the market conditions I am almost sure most of these options will expire unexercised

You can calculate the returns from this kind of a trade. The margin for selling one lot is around 18000Rs (And this is almost same for 5200 and 5700 options). So if I calculate the least returns on a 5700 Call say for 2 months (you can also cover it now if you want) it will be around 1400Rs for an investment of 18000 for 2 months. This itself is around 45% returns per annum with a very low risk strategy.

And for this you do not have to shell out money as I have mentioned. Pledge your existing shares and pool the margin money and reinvest the premium got.

Since all these options have reduced to penny Friday I have reversed the trade I covered the 5700 and 5600 call options so that I can release my margin and sold some out of the money put options.

4600 Put option at a premium of 70Rs (x number) (breakeven 4530)
4500 Put option at a premium of 35Rs (5x number)(breakeven 4465)
4400 Put option at a premium of 23Rs (10x number)(breakeven 4377)

Even though I am bearish on the market in the short term I do not expect it to touch 4500 by February since the budget event will keep the tempo of the market slightly high.

Now lets see what is the fate of these options :-)

Maximize your returns using Options !!

If you read my Investment Philosophy I am sure I do not feel like a trader or speculator who dances to the tune of the market. Yet my next post is how to effectively use index options to maximize your returns in the market.

Even though I prefer to invest in companies after lot of research, eventually I am in this market to make money. So it really does not make any investment sense to put restrictions like only generate returns by investing long term in the market. In fact I have figured out a way to generate some very handsome short term returns by effectively using index options without sacrificing by long term goal of good returns from stocks. (I have not applied for patent for this strategy yet :-) since it is a very common strategy used by many people)

And the returns are pretty handsome anywhere between 35% and 60% per annum depending on your risk profile. And more over this will come as a byproduct of your existing investment in stocks which will eventually add up to the returns that your stocks make.

Now before I discuss this strategy I would advise you to read my Disclaimer. This is because what I will be discussing now will qualify has a high risk strategy for some people. My risk profile is above average and all my strategies are aligned towards that risk strategy. So this goes as a special note of caution. Please do not follow this option strategy if you are not aware of the basic concepts of option trading. This strategy will expose you to very high risk some times. And at least once or twice in a year you are likely to face huge losses if market moves in one direction strongly (Like a Black Friday, or a golden Monday etc).

This article assumes that you are you are aware of the basic concepts of futures and options. This article is not a refresher to Futures & Options strategy.

A strategy where you can make unlimited loss and limited profits!!

Yes this strategy is all about selling options where theoretically you can make unlimited loss and limited profits. I know half of the people will stop reading this ridiculous post after the first line after all who wants to hear a strategy where your profits if any are limited and loss is unlimited. And moreover what is this all about selling of options, we as a conservative investors know only to buy options as a protection against market volatility and play safe.

Most of the investors think the same about options. These are safe way to play the market you pay a premium to buy a call or put option depending on the market conditions and make money from favorable market movements.

However how many of us including me has lost the money while buying options due to any of the following condition.

• My option simply expired as the market did not move as expected
• My option expired since market moved in the opposite direction.
• Market moved in the direction as I expected still I made a loss as the premium I paid for the options was high.

Options are very brutal instruments where the time plays a key factor in deciding the value of options. We call it time decay. Time decay can destroy the value of your options under the following conditions even if the market moves against you but not in the same pace.

Confused!! No problem I have illustrations please be patient.

Now what if we can make this time decay favorably on our side and make some profits instead.

The Strategy

Simple sell far out of money call / put options and pocket the premium in advance and wait for the time decay :-)

All of us know for buying the options we need to pay a premium and the seller of the options will get the premium upfront and will assume all the risk in case the buyer wishes to exercise the option in his favor. This is what I meant by unlimited risk earlier.

So what if there is any option which I can sell where there is very less chance of getting exercised? In that case I can pocket my premium upfront and wait for that option to expire.

However the key to this strategy to workout properly is the timing of selling the options. This timing can determine at the end how much you make as profits every month.

Sell Call Option when market is going up and Put option when it is going down

The idea behind this strategy is to capitalize on the market fatigue after it has made a move. Market will always over react on its way up and way down. You can find instances of this over reaction every monthJ. For example in the first half of this month the market was about to touch 5300 and most of the people in the market were predicting 5500 by the end of January. You open CNBC and you will be flooded with analysts who were predicting a level of 5500 as an immediate target for Nifty. The most surprising fact is that even though the markets were rising steadily for last two months from 4700 to 5000 to 5250 many people simply forgot the basic principles of life – “What goes up will come down”. You throw a stone up, depending on the speed that you throw it will go up initially covering more distance with less time and slowly the fatigue starts kicking in the speed reduces and there will be a position where it is in no position to go up and the only way is to go down. This is the same case with the market. When markets where at 5300 people were expecting it go to 5500 so the best thing to do over here is sell the 5600 call option and pocket the premium (say 50Rs).

If you have sold the Jan 5500 call which was quoting at around 50Rs during Dec the current price for that is around 0.6Rs (yes 60 paisa). You do not need to cover it even now just wait for 2 more days it will expire (means the price will reach zero).

The same is applicable for put options also. In just 3 days the market has retraced from 5270 to 5000 now. If you see 4500 Feb put option it is trading at around 25Rs. If you believe that the market can go down but not to 4500 in Feb then you can sell this option and pocket the premium.

Biggest margin of safety while selling Call options

I like selling call options than put options. One of the main reasons behind this is that there is very little chance of making absolute loss if you follow some steps.

• Always keep the margin for selling call options as stocks and not as cash

Normally for selling one lot option the retail margin is anywhere between 17000 to
20000Rs. And this can vary from broker to broker. Most of the brokers will have an option
to keep this margin either as cash or as pledge of equal value of stocks. So in worst case
scenario even if the market rises to your option level your stock price will also rise (the price of the pledged shares)

• Your pledge stock price also rises with the market giving you more room to sell options at higher levels.

Finally

So that’s all about this strategy as of now. I am thinking of a section where I can discuss every month which option are sellable from my point of view. Let me know what you think of this so that I can plan for this.

So for me this is just a way to maximize the returns of the stocks which I hold for long term where I pledge those shares create margin money and use that margin to sell the options. A simple calculation shows the returns from this strategy anywhere between 55-60% per annum if you execute these trades smartly. And more importantly never try this strategy in stock options as there will always be a stock specific risk

My Investment Philosophy!

Every serious investor in this market should have an investment philosophy which he should use as a guiding tool for his behaviour in the market. This is very important because as time goes on you learn many things and fine tune your investment guidelines which suites best to you.

All investment strategies are good ie Long term , short term , Value buyer , Growth buyer, Trader , Jobber ... The point here is you should have one. :-)

Now here goes my investment strategy. This is very important for a reader as you will understand the background from which i am writing on the stocks i like.

I am a growth investor. That dose not mean that i will buy some stocks and sleep on it for ever. I am always looking for companies that are growing always irrespective of market conditions. I do not invest in already discovered ideas for the simple reason that there is not much to expect from it when it comes to returns.

My risk profile for investing is above average. On a scale of 1-10 my risk taking ability is around 7. Which also means that i dont mind investing in a high risk - high return company if i get it at a reasonable valuation.

I love sustainable / recurring revenue stories with a slight high entry barrier in terms of setup cost or technology availability. I am willing to pay a high multiple for such companies.

I do not like highly leveraged companies (high debt equity ratio) or companies with negative cash flows.

I normally do not invest in commodity companies as these are normally cyclical in nature. I also do not like real estate companies as i still could not digest their business model and also due to transperrency issues.

As such i do not have any dislike for trading but i rarely does it. Infact i will share with you some option trading strategy which i religeously follow every month :-)