Exploring Index Options

Last Updated 30 December 2018, 16:57 IST

The Indian Option market is growing rapidly over the last couple of years because of its multifold advantages like higher liquidity, less transaction cost, flexibility, hedging, arbitrage, user-friendly, customised strategies, limited or calculated risk and rising knowledge with better understanding among the market participants. Traders are nowadays quite familiar with many well-known and low-risk option strategy and can also understand the effect and benefit of time decay.

Index Options gaining a significant share of overall business: In the Indian derivatives market, options of Nifty and Bank Nifty contribute around 80-85% of the total turnover. Nowadays, weekly expiry of Bank Nifty and monthly expiry of Nifty attracts huge participation because of its inbuilt features.

As per the exchange daily turnover data, if we are not contributing in Option segment that means we are missing a big basket of the market, business and trading opportunity. An analysis of average daily turnover data from NSE suggests that the contribution of Index options in the exchange’s overall business has increased significantly over the last few years. In FY18, the share of Index options in the average daily turnover stood at 78% which has increased to about 82% in FY19 so far.

Use of Options trading to benefit from the current volatile market: Option market provides a huge opportunity to option buyers to play the volatility of expiry day by just paying a small premium amount and that is the only reason that Bank Nifty expiry makes everyone to participate in it. While Option seller gets a better return on investment by selling near the money or out of the money strikes with the aim to get benefit from higher time decay with higher probability.

Option buyers and sellers are gaining with option premium, market volatility and that is the reason that volumes on weekly expiry of Bank Nifty go to 15 lakh crore shares in a single day. The advantage of Option strategy is that it can be applied for any kind of expected market move and it is suitable for all clients.

One can trade in Options even while expecting a range bound or volatile move. Options trading has two big advantages over almost every other form of trading. The first one is the ability to generate profits when you predict an underlying asset to be relatively stable in price, and the second is one expects a volatile move.

Options can also be used in a volatile market through various option strategies. These are designed specifically to make profits from stocks or index that are likely to experience a dramatic price movement, without having to predict in which direction that price movement will be. It’s a question of long debate that one should buy an option or sell an option and the right answer is - it depends on the profile, market set up and scenario, among others.

Vanilla Option Buyers / Option Seller or something else: It’s a normal question in the mind of every new person who wants to be in this wide market. As per the probability, an option seller makes more money than an option buyer but the risk-reward ratio always favour to the buyer of that option whether it’s Call or Put.

The advantages of Option strategies especially applying with Straddle and Strangle is the only option which allows traders to play the volatile move even without knowing the direction of the market.

Everyone knows that 2018 has been a tough and rough year where money making is not an easy task, so such strategies will help clients in the upcoming events like elections, other domestic and global events.

We have noticed and have been suggesting many high probable option strategy like Call Ladder Spread, Put Ladder Spread, Bull Spread, Bear Spread, Butterfly or Condor. Many times a 10-point risk of option strategy has made 7 to 8 times return in Bank Nifty weekly expiry.

Volatile options trading strategies include Long straddle and Long strangle.

Volatile options trading strategies include Long straddle and Long strangle

Range bound strategies include short straddles, short strangles, iron condor, etc.

Selling options in volatile scenarios can be very tempting but it is extremely important to be hedged, otherwise, the risk could be much higher if someone is wrong.

Four legged options strategies such as Iron Condor and Iron butterfly give a perfect hedge.

nA covered call is a very effective and yet simple strategy that works very well. In fact, it is designed to make the maximum amount of money in moderately bullish to volatile markets where the price of the underlying is within a tight range and the options premiums are high.

Covered Call is the only main strategy which can reduce the cost of holding position or allow a person to get the lower break even points however sometimes reward could be capped.

A common misunderstanding is that option trading is a tough task, but in reality understanding of basic concept and practice with few live strategies would make traders get a strong grip on this overwhelmed subject.

(The writer is Derivative and Technical Analyst at Motilal Oswal Financial Services Ltd (MOFSL)

(Published 30 December 2018, 15:32 IST)

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