Trading Options - Long Strangle

So what is Strangle?

Just like in previous post, you are unsure of direction of the big move. However you have inkling that it is more likely will be in positive direction. At the same time, you don’t want to bet in one single direction and want to cut your losses in case you are wrong.

So Strangle comes to your rescue. Only difference between Straddle and Strangle is that the Strike Price of the Call and Put options is different. In Strangle for our scenario, you buy 5000 Call option for 100 Rs premium (5000 Rs) but while buying Put option, you buy 4800 Put for 25 Rs premium (25 x 50 = 1250 Rs). What this basically does is that your break-even point on the (more likely) positive side is reduced and you start making money as soon as NIFTY crosses 5125 level. Graph is once again helping us understand it.

You are making money earlier in positive direction and at the same time you are protected from extreme downside. So if market drops sharply, your put option gains in value. It reduces your overall loss or in extreme down move, you can still make money albeit a little less. Break-even on upside is 5125 and on the downside 4675. You are in a better position to benefit more and sooner from the positive move (which we believe is more likely at the start) and still have some protection from the downside. Like in previous post, this is a long strangle.

Now, let us talk about not holding these positions till expiry date as we have been assuming for last three posts. Take example of Strangle trade in this post. If you see that you are wrong and market is moving in opposite (negative) direction, the Call Option premium will start dropping. So rather than holding it till very last date… you square off your Call position (you sell the same option) back in the market for let us say 50 Rs Premium losing 2500 Rs ((100-50) x 50 = 2500 Rs).

At the same time, since market is moving in negative direction, your Put Option premium will rise in value and 25 Rs premium may quickly jump to 50 Rs. Since the market is anyway moving in negative direction, you may want to hold Put Option a little longer and actually recover entire loss in Call premium through you Put position. Strangle is usually more popular and practical strategy for newbies.

For executing any of this, you will have to be an active trader and keep a decently continuous eye on the market. And I cannot over emphasize importance of Stop-Loss (details and how to use it will be explained in some other post) in these trades. If you have any questions so far, feel free to shoot them to me. Rest assured, I will not try to dodge them.

Trading Options - Long Straddle

If you are sure about a big move in Market but not sure about the direction, straddle and strangle are two options strategies that are tailor made for you. Both strategies consist of buying an equal number of call and put options with the same expiration date. There is slight difference between the two though.

First let us understand Straddle.

In this case, you just buy a Call Option and a Put Option for same Strike Price and same Expiry. Continuing from previous two posts, let’s say you buy 5000 Call and 5000 Put for 100 Rs Premium each and lot size is off course 50 (You pay 5000 + 5000 = 10000 Premium). Now when the budget is announced, market reacts sharply either in positive or negative direction with a big move. Following graph shows your Profit/Loss with respect to NIFTY level. Please note that, in this case too we are assuming that you continue to hold both the positions till expiry date. Usually you don’t do that and hence either your losses are much less and your profits are little higher. We will explain that too in some other post.

So basically, 4800-5200 is the range where you do not earn money. When NIFTY moves beyond this range then you start making money. E.g. At NIFTY of 5100 you recover 100 Rs premium through you call option but still you have lost your 100 Rs premium of put. When NIFTY moves beyond 5200 then both your premiums have been recovered and you start counting your blessings.

Please try to understand that this strategy is very useful when there is some big move in the market. In a sideways market, you are more likely to lose your premium and hence it must be used only in strongly trending or news based market. Moreover, when there is expected to be a big move, option premiums tend to increase so your overall profit is affected to some extent. Try checking Infosys option chain premiums near their result date.

One more thing, buying straddle here is referred as Long Straddle. You can also sell straddle and there is no price for guessing its name as Short Straddle. We will discuss about it when we get to selling options.

For other scenarios, we always have Strangle. You will have to wait till next post though…

Strategy - Buying a Put

Continuing from where we left in the last post…

This time, let us say that your analysis shows that there is a good probability that NIFTY will be going south by the target expiry date. Since you do not want to bet on one of the 50 stocks of NIFTY, you simply buy NIFTY Put Option. Let us say you buy NIFTY 5000 Put at 100 Rs Premium (100 x 50 lot size = 5000 Rs) and then as in previous post, you forget it… you do not square it off and sell your position. You wait till the expiry date for exchange to settle your option. Below figure tells you what is your profit or loss from this transaction depending on various levels of NIFTY.

Everything in last post also applies here. As you will see, if NIFTY is above 5000, you have lost your premium in total because you have bet NIFTY to fall and Put option above strike price is worthless. If NIFTY is between 5000 and 4900 then you recover some of your premium. Let’s say NIFTY is at 4930, so exchange gives you 3500 Rs (70 x 50 lot size) and your loss if 1500 Rs. In case, your analysis is correct and NIFTY lost much more and settled below 4900 then your trade is in profit at expiry and your profits are directly proportional to NIFTY level below 4900. E.g. if NIFTY is at 4800, exchange will give 10000 Rs (200 x 50) and you would have made 5000 profit after removing the 5000 Rs premium you paid.

It’s very simple so far… right? But what do you do when you are not sure of direction of the market? Let us say that you are pretty sure that after the RBI meet (or budget) market is going to react sharply. In which direction? You have no idea. You are pretty sure about the big move but you do not have any inside information about RBI Policy or Budget Provisions (welcome to the majority)…

Don’t worry, help is at hand. There are strategies which help you take advantage of such situation too. Stay tuned for next post…

Oh yes, I wish Happy Dassera to all of you and your families. Have a great time.