I will use this opportunity to discuss some of the Greeks in options.
This strategy uses the behaviour of options as measured by the option Delta.
Option Delta is the change in the price of an option for a one point moves in the underlying.
Call options: 0 greater than Option Delta greater than 1
Put options: -1 greater than Option Delta greater than 0
1. In-the-money options: Delta Option approaches 1 (call:+1,put:-1)
2. At-the-money options: Delta is about 0.5 (call:+0.5, put: -0.5)
3. Out-of-the-money options: Delta Option approaches 0.
This strategy uses the above three properties of Delta.
Strategy: Buy an out-of-money CALL and PUT option with the strike price on either side of the SPOT or Futures Price.
Example:
Nifty SPOT 3947.2
So buy the Nifty CALL option with strike price of 4100 (premium - 65.05)
and buy the Nifty PUT option with strike price of 3800 (premium - 95)
If the market goes up then the Nifty CALL will appreciate faster than the rate at which the Nifty PUT depreciates.
The vice versa is true if the market goes down.
Advantages of the strategy
1. It is hedged, so the risk is reduced.
2. Useful in markets where market direction is unclear.
Disadvantages:
1. It assumes that the SPOT and Futures price are the same. A change in the discount /premium of the future to the spot could upset calculations.
2. It does not take into consideration the time decay of options.
So it is suitable only for short term trades - from one day to a week.
3. Useful only if the market has moved in one direction during the period of investment.
OT
PS: Assume that this position was taken at yesterday's close price and see where it ends today. |
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