Option Strategies.
Before going to Option strategies understand the option " GREEKS ".
Option Greeks:
These values are used to evaluate various
option positions and measure the risk involved.
Delta:
Delta measures the option price sensitivity in relation to the underlying asset. It is given as the number of points the option is expected to move for each point change in the underlying asset.
This is the most used in the Greeks and it is important to know because it tells how the option value will change based on price fluctuations of the underlying asset.
Delta is usually expressed as a value between 0 and 1 for call options and between 0 and -1 for put options. The closer that Delta gets to 1 (or conversely -1) the more valuable is the option.
Example :
In this example Nifty delta for call option is 0.47 and put option is -0.54, means for every one point up move of Nifty the call option moves +0.47 points and put option moves -0.54 points. If Nifty moves one point down side call option moves -0.47 points and put option moves +0.54 points.
Gamma:
Gamma is a measure of how much the option’s Delta changes when the price of the underlying asset changes. It is used when trying to assess the price fluctuation of an option in relation to how far in or out of the money it is.
Gamma values increase as an option gets closer to being at-the-money. As an option moves further either in-to-the-money or out-of-the-money, the Gamma value will decrease.
Rho:
Rho is an estimate of how the price of an option, its premium, will change with respect to interest rate changes. Typically, if there is an increase in interest rates, then the premium on call options will rise and put option premiums will decrease.
Vega:
Vega is a measure of the sensitivity of an option to the volatility of the underlying asset. The more time there is to the expiration date, the more the option will be impacted by increased price volatility. Increased volatility will increase the value of an option.
Theta :
Theta is a measurement of the sensitivity of the option to time decay. It measures the amount of value that the option will lose for each day it gets closer to its expiration.
Example :
In this example Theta Value of Nifty 11700 CE is -4.28 and 11700 PE is -3.56. Means every day the call option value decrease by -4.28 points and put option value decrease by -3.56.
Option Trading Strategies
Before you begin trading options, you need to have a strategy. You should know your investment goals and pick a strategy that will help you reach your goals. And investor who is looking to protect himself against potential losses on stocks he already owns will choose a different strategy from one who is trying to profit from the increased leverage that options can provide.
Simple Strategies :
If you are a beginner when it comes to option trading, then starting off with a few simple strategies is probably the best way to start. As you gain more experience and become more comfortable with trading options you can move on to more complicated strategies.
Long Call :
Buying call options is a popular strategy for all levels of investors. In this strategy, you purchase call option of underlying asset that you believe is go up.
If the stock price is higher than the strike price plus the premium paid by the expiration date then you will make a profit. If you are wrong, then you potentially lose your entire premium.
The majority of call option contracts are sold before expiration, when the premium goes up.
To make a profit with this strategy, you need to have good timing and you need to know when you should exit the contract. If you wait too long and the stock does not rise high enough or fast enough, then the option may not be worth.
Some investors choose to buy call options instead of buying stock on margin. They offer the same use of leverage but carry less risk. If you have bought a stock on margin and the stock falls, you may get a margin call and be forced to add cash or liquidate assets to meet it. The only risk you face with buying call option is losing the premium.
Long Put :
Put buying is much the same as call buying except in this case you believe the underlying is headed downward. An investor would use this strategy as insurance against losses on assets already owned or to make a profit in a bear market. If you believe the market, or a particular stock, is headed down, then this would be a good strategy to consider.
This strategy is often used by stock owners to lock in a selling price and protect themselves against stock declines.
It can also be used for speculation on stocks that you don’t own. As the price of the stock declines, the premium on the option should rise allowing you to make a profit.
Covered Call :
Simple strategy is to write a covered call. In this straight forward strategy, you would sell (write) a call option for stocks that you already own, or purchase shares at the same time as you write the call.
An investor would choose this strategy to generate additional profits on a stock that does not feel is headed higher, at least in the short term. In this way, the covered call acts as a dividend on the stock.
Married Put :
A strategy in which you buy a put option on a stock which you already own or buy at the same time with the put is known as a married put. An investor would use this strategy to protect against losses if the stock price drops dramatically. It functions basically as an insurance policy
Spreads :
A spread is a strategy that involves two transactions, normally executed at the same time. Spreads are a little more advanced than the simple strategies covered so far, but they are useful tools and well worth learning about. The most common type of spreads are vertical spreads, in which one option has a higher strike price than the other. In a spread, each transaction is referred to as a leg.
The advantage of a spread is that your risk and potential losses are minimized. The disadvantage is that your profits are also limited.
Bull Call Spread :
This type of vertical spread is used by bullish investors. The investor would buy call options on a stock at a certain strike price while simultaneously selling a call on the same stock at a higher strike price. Both options would have the same expiration date.
Bear Put Spread :
This is also a vertical spread. In this strategy, you would buy put options at a certain strike price and then sell the same number of puts at a lower strike price, both on the same underlying asset with the same expiration date. This is a strategy for bearish investors who think the price of the underlying asset is going to decline. Used as an alternative to short selling a stock.
Calendar Spread :
A calendar, or time, spread involves purchasing an option with one expiration date and then selling another with a different expiration date. The strike price for each would be the same. In this strategy you are hoping to take advantage of time decay.
Butterfly Spread :
Butterfly spreads are somewhat complicated and best used by more experienced investors. In this strategy, an investor combines both a bull and a bear spread strategy, using three different strike prices.
Straddle :
A straddle is used by an investor who believes a stock is going to move significantly in one direction or another but isn’t sure which direction that it is going to be. In this strategy, you would purchase both a call option and a put option on a stock with the same strike price and the same expiration date. These offer unlimited profit potential while at the same time limiting risk.
Iron Condor :
The iron condor is a complex strategy that involves simultaneously holding a long and short position in two different strangle strategies. In this strategy, the investor sells an out-of-the-money put option, buys another out-of-the money put option with a lower strike price, sells an out-of-the-money call option, and buys another out-of-the-money call option at a higher strike price. This strategy offer limited risk and a good probability of earning a small profit.
Iron Butterfly :
This is another complex strategy used as a limited risk, limited profit combination. In the iron butterfly strategy the investor buys an out-of-the-money put, sells an at-the-money put, sells an at-the-money call, and buys another higher strike out-of-the-money call.
Naked Calls :
A naked call is a high risky strategy in which an investor writes call options on an underlying asset without ownership of that security. It is risky because if the buyer of the call option exercises the option, then the seller must buy the stock at the current market price in order to fulfill the buyer order. The risk in this case is unlimited because there is no way to control how high the market price of the stock will go.
Collars (Protective) :
In this strategy, the investor purchases an out-of-the money put option while at the same time writing an out-of-the-money call option on the same stock with the same expiration date. This is used by investors to lock in a profit without selling the stock.
Strangle :
In the strangle strategy, the investor buys both a put option and a call option, both usually out-of-the-money, on the same stock with the same expiration date, but with different strike prices. This is used when the investor is unsure which way the stock is headed.
Strategies by Market Outlook :
Below is a list of strategies to use based on your current outlook, either toward the market as a whole or toward a particular security.
Neutral Strategies
· Butterfly Spreads
· Calendar Spread
· Collar
· Iron Condor
· Married Put
· Straddle
· Strangle
Strategies for Bulls
· Bull Call Spread
· Bull Put Spread
· Collar
· Covered Call
· Long Call
· Married Put
· Short Put
Strategies for Bears
· Bear Call Spread
· Bear Put Spread
· Long Put
· Naked Call
· Short Call
Exit Strategies :
It is vital to plan your exit strategy before you begin trading to avoid taking unnecessary losses. You can exit, or close, your position at any time before the expiration date. The timing of your exit is very important and can make the difference between making money and losing money. Before you begin, you should decide how you will exit if your option is out-of-the-money, at-the money, or in-the-money.
Closing Out :
One way exit to is by closing out your option. This is done by either buying an option you sold, or selling an option you bought. Basically reversing your position. If the premium has gone up since you bought the option, then you have made a profit. If the premium has decreased, you may want to cut your losses and sell.
As an options writer you are almost never forced to fulfill the obligation to buy the underlying security because you can close out your position before it is exercised.
Again, timing is everything when it comes to option trading and you must keep a close eye on your investments with regard to when it is time to sell, either to take your profits, or to cut your losses and move on. The closer you get to the expiration date, the more volatile the options become, and so you need to monitor them even more closely.
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