If you are a beginner or intermediate-level options trader or want to start options trading but are still figuring out where to begin. In that case, the newsletter can help clear many options trading concepts.
Let's get started:
Option Buying Vs Selling
Option Sellers can generate some profit even if the underlying asset is not moving anywhere (sideways market)
However, the buyers can make money only if the underlying moves in their intended direction more than a certain number of points (trending market)
Option Seller's main advantage is "Time benefit."
In technical terms, it's called Theta Decay.
Theta Decay means an option premium loses its value over time as it comes close to expiry.
Let's understand the concept of Theta Decay with an example.
As of June 9th (Friday) Nifty 18600 Option with June 16 Expiry is trading at Rs.77. Its Theta value is "-10", which means the Option value will be decreased by approximately Rs.10 by the end of Monday no matter what happens in the market.
Remember that Option Seller always prefers selling at high premiums and wants to square off, then the option loses most of its value.
So the premium loss due to Theta Decay is a sure-shot profit for the seller, and whatever is profit for the seller will be a loss for the buyer.
So the Time Decay / Theta decay is the main factor differentiating between option buying and selling.
Which one is more profitable:
Both have pros and cons when consistently generating profit over time.
Option Buying:
Option Buying can generate more ROI if done correctly by following all the rules of proper risk management because the investment needed is less.
However, the main downside of Option buying is, controlling the emotions of greed, as it costs less; most traders tend to either take more lots or try to double their money quickly, which is when they start losing big.
Another main factor many options buyers can face is they can't sit idle. 5/10 days are only suitable for options; the rest of the time, it's better to stay idle, which many traders won't do.
Option Selling:
On the other hand, Option Selling is an Art, where you expect a minimal return, like 1 to 2% f your capital a week, but your main focus is getting a high success rate.
Option Sellers generally deploy high capital, so even if they generate less monthly ROI, it will compound well in money terms.
Conclusion:
If I have to pick only one, In the long run, when you accumulate decent capital, you can prefer doing option selling mainly and keep re-investing the profits to grow your capital. Apply the power of compounding.
Initially, do not have any biased view on both buying and selling; depending on the knowledge, capital and experience you got, you keep testing both buy and sell strategies in the live market.
Over time you can combine both of them and follow a mixed approach which is suitable for you.
My Preference:
I keep doing both of them, depending on market situations.
In Intraday momentum markets, I prefer Option Buying; in case of Expiry days, I might like Option Selling, and for positional trades, I like weekly or monthly option selling with adjustments as needed. I also deploy spread strategies for swing trading purposes.
Depending on VIX levels, also I keep changing the strategies, which we will discuss in the upcoming topics below:
Margin Requirement for Options Trading:
Option Selling generally requires 10 to 20 times more capital than Option Buying because of the "UPSIDE RISK."
It means, say, you bought a CE at 100, and Nifty fell by a few points by the expiry so that the option value will become 0, and you get a loss of 100*50 = 5000 means the max loss is only 5000 per lot.
However, say you sold a CE at 100, and Nifty started to move up significantly; then there is a chance that 100 can even become 500 or even 100, depending on how big the upmove is.
So for a naked option seller, there is always a risk of a premium increase, and there is no practical limit to it.
So the brokers will ask for a higher margin to sell any option to cover the worst-case scenario of a huge premium increase when the market goes against them significantly.
Approx. margin needed to deploy the below strategies:
1. To buy any naked option worth 100, it would cost 100*50 = Rs.5000; if the option is worth 200, then it will be 200*50 = 10,000
2. Selling any naked option can cost between 80k to 1.5 Lakh, depending on your strike price.
3. To create Spread Strategies like Bull Call Spread, Bull Put Spread, Bear Call Spread, Bear Put Spread, Call Ratio Back Spread, Put Ratio Back Spread and Calander Spreads will cost between 25 to 40k per lot, depending on the premiums.
However, Spreads like Put Ratio Spread and Call Ratio Spreads will cost more than 1 Lakh because it involves an extra sell leg position.
4. Non-directional Strategies like Straddle & Strangle can cost 1 to 1.5 Lakh. Iron Fly & Iron Condors can cost around 40 to 60k per lot.
Which one is suitable for Beginners:
If you are getting started with Options Trading with a capital of less than 1 Lakh, I would suggest you start with the following:
For Intraday: Either naked Option Buying or Spread Strategies (Debit Spreads)
For Positional: Spread Strategies (Both Debit & Credit Spreads)
On Expiry Days: The Call Butterfly Strategy - Will be discussed below, or Naked Option buying (case of trading Expiry)
Never risk more than 2% of your capital for any strategy you do.
Once you get comfortable doing these, you can get into a few non-directional option strategies. Option Selling requires more capital, knowledge, and expertise in adjustments etc.
Suitable Strategies during Expiry Days:
As mentioned above, my preferred strategy on expiry days is the
Call Butterfly strategy.
It is a limited loss, high probable Option Selling strategy with limited risk.
It works much better when the VIX levels are at least 14 or above.
Even due to low VIX levels, you can apply this, but you need to expect less reward for the risk that you are taking, like 1:1 or 1:2, which is less than usual.
This strategy needs a detailed explanation; you can make use of below Instagram post & YouTube video I made on this expiry day strategy to understand it better:
Expiry Day Strategy Instagram Post
Expiry Day Strategy YouTube Video
Zero-to-Hero Strategy:
Like we talked about in the previous newsletter, you can also try the Zero to Hero strategy on specific expiry days, especially during trending expiries.
If you missed reading that, you can check it out here.
Suitable Strategies during Low VIX Scenarios:
When VIX is low (<14), the overall option premiums are generally lower, which makes non-directional option selling less attractive.
In such situations, we can't always rely on Theta Decay to make profits. We also need to capture some Delta benefits or Vega Benefits.
You can check out this Instagram post I created a few months ago on preferred strategies during low VIX levels.
Additional Resources to Learn Options Trading Better:
Free Options Basics Course
Learn A-Z of Options Trading
That's it for this newsletter; see you next Saturday;
Feel free to reply to this mail to let me know how this newsletter has helped you.
Have a great weekend :)
- Arun Bau
