OPTIONS TRADING STRATEGIES – A BEGINNER GUIDE
Introduction
Options trading is considered a complex financial instrument. If you learn well and work in options trading with a positive mindset, you can have a good business. It is not so easy for those who are new to options trading. Trading strategies are required to reduce risk and achieve better returns. Today we will learn about those trading strategies through this article.
Options trading has become very popular in today’s trading market. Investments are less, risks are less as compared to FUTURES but risks are always there in the market, whether we talk about Nifty/BankNifty options trading or stock options, a lot of volume has been seen in all of them for some time now.
Traders buy options in the hope that the investment will double. This is the biggest reason for losing mindset. If you want to make good and regular money from options trading, then you have to adopt the right approach and the right strategy. If you are not trading options with the right strategy then you are just gambling with your capital. Today we will talk about the same strategy.
Understanding Options Trading Basics
Options are contracts that give traders the right to buy or sell an asset before a predetermined expiry date. This is a right for traders, not an obligation. Call options are used to buy during bullish times and sell during bearish times. Put options are used to buy when the market is falling and to sell when the market is rising.
Key Concepts for Beginners
Understanding Greeks is also very important in options trading. Delta, Gamma, Theta, and Vega, all four Greeks together affect the options price. Additionally, mastering the importance of strike price and expiration date is fundamental.
Common Pitfalls to Avoid
Avoid excess trading, avoiding trading against market trends, and inadequate research are some of the reasons that can cause losses for new options traders. Avoiding losses is as important as implementing trading strategies.
There are many types of option strategies in the market, but you do not need to understand all of them, you can earn good profits by understanding some of the best strategies. Understand the market trend and make an option strategy accordingly.
BULLISH STRATEGIES (BULL MARKET)
BULL CALL SPREAD
BULL PUT SPREAD
BEAR CALL LADDER
CALL BUTTERFLY
BEARISH STRATEGIES (Bear Market)
BEAR CALL SPREAD
BEAR PUT SPREAD
BULL PUT LADDER
NEUTRAL STRATEGIES (range market)
LONG & SHORT STRADDLES
LONG & SHORT STRANGLES
LONG & SHORT IRON CONDOR
LONG & SHORT BUTTERFLY
We will understand all the option strategies one by one so that there is no confusion.
We will talk about IMPLEMENTATION, PAYOFF CHART, BREAKEVEN POINT, and which strike price should be chosen in each strategy. I hope everyone knows about the strike price.
I want to make one thing clear, there are no 100% MONEY MAKING strategies, a lot depends on how we use the strategies correctly.
Let’s start with BULL CALL SPREAD
SPREAD strategies are MULTI-LEG STRATEGIES, which means trading in 2 or more options.
In BULL CALL SPREAD strategies, your viewpoint is only bullish but not too long bullish, be it index or any stock.
For example, the results of any stock are about to be announced. If the management of the company had expressed the expectation of excellent performance in the previous results, then it is clear that the results will be good mostly when any news is known in advance.
If so, the market digests it before that, now the movement of the stock will be upward but it will not be very fast because the market has already digested the good results. In such a situation, we will use the BULL CALL SPREAD strategy here. Technical analysis should also be done simultaneously, which trend is the stock in, whether it is an UPTREND or DOWNTREND, and whether it is on support or resistance.
In this strategy, we will buy one ATM (AT THE MONEY) call and one OTM (OUT OF THE MONEY) call.
Will sell. Take special care of these 2 things:
1 Both options should be of the same expiry
The quantity of 2 more options should be equal. It should not happen that 1 option is bought and 2 are sold or 2 are bought and 1 is sold. Trade should be done in equal quantity.
In such a situation, there are 2 benefits of adopting this strategy.
1. Even if your view is wrong, you will be able to HEDGE your losses with the OTM calls you have sold.
2 These types of trades usually involve low investment or low costs.
I will tell you further how your profit in this strategy will remain CAPPED, that is, it will remain limited.
Suppose ICICI Bank is trading at Rs 500, after the result it is expected to go up a little but not a little more, in such a situation the strategy will be
Will buy ATM call at strike 500 and sell OTM option at strike 520
Bought a call of Rs 500 for Rs 20
Sold call of Rs 520 for Rs 15
If you bought a call for Rs 20 then this DEBIT transaction will happen and money will be deducted from your account.
If you sell a call for Rs 15, the money will be credited to your account.
20-15 = Rs 5 will be debited from your account
Here the calculation of deposit and deduction of money will be according to option premium * lot size.
Now we see this trade in different situations on the day of EXPIRY.
Situation 1: ICICI Bank closed at 490 on expiry
Had bought a call of Rs 500, the intrinsic value of this call became 0 ( 0, SPOT – STRIKE ) (0, 490 – 500) = (0, -10 ) = 0
When we sold a call for Rs 520, we got a premium of Rs 15 in our pocket.
– 20 + 15 = – 5 rupees loss if ICICI Bank expiry is at 490.
Situation 2: ICICI Bank expires at Rs 500
Still, there will be a loss of Rs 5 because the call of Rs 500 will become zero and if we had sold the call of Rs 520, we would have eaten the entire premium. -20 + 15 = – 5
Situation 3: ICICI Bank EXPIRES ON 510
The value of the Rs 500 call will be Rs 10 (spot strike) (510-500) = 10, a premium was bought for Rs 20.
20 – 10 = loss of Rs 10
Had sold 520 calls for 15 rupees, and 520 calls became 0 on the expiry day, so 15 rupees were all ours.
15 – 10 = profit of Rs 5
Situation 4: ICICI Bank EXPIRES AT 520
The value of 500 calls will be Rs 20 (SPOT – STRIKE) (520 – 500) = 20, had bought for Rs 20, so no loss, no profit.
The call of 520 that was sold will become 0 (SPOT – STRIKE) (520 – 520) = 0
0 + 15 (We sold this premium, hence the entire Rs 15 is ours) = We will get a profit of Rs 15 if ICICI Bank expires at Rs 520 on the expiry day.
Situation 5: ICICI Bank EXPIRES AT 530
The value of the call of Rs 500 which was bought will become Rs 30 (SPOT – STRIKE) (530 – 500) = 30, it was bought for Rs 20, 30 – 20 = profit of Rs 10.
The value of 520 calls which was sold will be Rs 10 (SPOT – STRIKE) (530 – 520) = 10
520 call was sold for Rs 15, its final value was Rs 10, hence the profit was Rs 5.
Total profit was 10 + 5 = Rs 15.
So you see two things are very clear, if ICICI Bank closes down then the LOSS is limited to Rs 5. Profits are also limited to Rs 15.
BULL CALL SPREAD MAX PROFIT = SPREAD – NET DEBIT (20 – 5 =15)
BULL CALL SPREAD MAX LOSS = NET DEBIT OF THE STRATEGY ( 5 )
SPREAD = DIFFERENCE BETWEEN THE HIGHER & LOWER STRIKE PRICE ( 520 – 500 = 20 )
NET DEBIT = PREMIUM PAID FOR LOWER STRIKE – PREMIUM RECEIVED FOR HIGHER STRIKE (20 – 15 = 5 NET DEBIT in this strategy)
I hope friends, you have understood from this example when and how to use BULL CALL SPREAD STRATEGY. We will understand about BULL PUT STRATEGY in the next blog. Please subscribe to my website, it is free, and there are no charges, in a way it will be your love which will motivate me more to write blogs on other topics related to trading.
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