Greek Stock Market
A low risk entry into the Indian options market by trading Nifty calendar spread
Just like there is many a method to do fishing from a deep and Wide Ocean, stock market is a deep and wide ocean there are many methods by which you can profit from it. And one of the methods for the experienced once is the options trading.
Introductory definitions
Expiration date: The day on which the option contract becomes void. the expiration date for listed stock options is the Saturday after the third Friday of the expiration month.
In-the-Money: A term used to indicate the option has intrinsic value. A call option is in-the-money if the underlying stock is higher in price than the strike price of the call option. A put option is in-the-money if the underlying stock is lower in price than the strike price of the put option.
Intrinsic Value: A calculated amount that represents the amount an option is in-the-money. this is the value of the option if it were to expire immediately with the underlying stock at its current price. For call options, it is the difference between the stock price and the strike price, if the difference is a positive number. Otherwise it is zero. For put options, it is the difference between the strike price and the stock price, if the difference is a positive number. Otherwise it is zero.
Naked Option: An option that is written (sold) without owning the underlying stock. The investor is uncovered or naked, since they do not own the underlying stock should they receive an exercise notice. If they receive such a notice, their broker will buy the underling stock at the market price to make good on the contract.
Out-of-the-Money: An option that has no intrinsic value. A call option is out-of-the-money if the stock is below the strike price of the call. A put option is out-of-the-money if the stock price is above the strike price of the put.
Premium: The total price of an option. The sum of the intrinsic value and the time premium of the option.
Put Option: An option granting the investor the right to sell the underlying stock at a certain price for a specified period of time. One put option is for 100 shares of the underlying stock. Generally, a put option will increase in value if the underlying stock decreases in price.
Strike price: The price at which the option holder may buy or sell the underlying stock, as defined by the terms of the options contract. This is the price the owner of a call may buy the underlying stock or the owner of the put may sell the underlying stock. Also known as the exercise price.
Time Premium: The amount an option’s total value exceeds its intrinsic value. Part of the time premium decays over time as the option approaches its expiration date.
As there are many a strategy that can be used depending on the market, whether it is a trending upwards market or downwards market or going sideways. And also strategies which are suitable for high volatility period and low volatility period etc are there.
Let’s keep our focus on one of them and that to on a low risk strategy, known as calendar spread.
Now strictly speaking a calendar spread is made up of 1 long option and one short option with the same strike price but different months. The short strike will be nearer month while the long strike price will be a further out month.
These are the basic characteristics of a calendar spread
- Put on for a debit ( in our strategy its nil no initial outlay or very less)
- Benefits from time passing
- Benefits from increasing volatility
- Defined risk trade
- Profit realized on closing the trade
As to when to enter the strategy ideally it should be when the low volatility period is ending and high volatility begins but as a newbie lets ignore all others greeks and concentrate and follow only cash or our money what it is doing.
And let me share an honest opinion about the hundreds of books and sites that publish and coach option trading, it is never like that in the real world it’s not that easy without experience and there are other lot of variables which no one can predict or define beforehand so the only way to learn is by leaning one step at a time and asking yourself questions and searching for answers.
As the saying goes its very easy to interpret the past say why it didn’t work or why it did work but to lay out a plan for the future is very difficult and we have to depend on experience and hunches and probabilities this was nifty position when I entered the trade.
Calendar spread basically is selling one month and buying another month, Nifty Index is a good one to trade because of the liquidity and the various numbers of strikes available.
Here I have taken an example from the recent nifty rates and its very realistic numbers maybe off by two or three points.
Let’s buy a 5400 Nov call, it was recently trading at premium of 44 points so imagine if we buy that and our money layout is very small around Rs.2200. Now to protect against the downside as per the theory one should sell a Oct call of strike 5400, but the problem is it never comes near in covering the amount, say we might be able to sell it for 15 points or 12 points etc, so do not go for that instead lets sell 5300 call we might get it around 37 points so that somewhat decently covers our downside with minimum risk of around 10 points.
Let’s see how this strategy pans out, if we enter the position in mid September and when spot nifty trading 4950.
our strategy is in short
BUY Nov 5400 call for 44
Sell Oct 5300 call for 37
Outcome scenario I.
If the nifty falls down all of a sudden our sold call will be immediately in profit, say the 37 points will come down to 15 or 18 because it’s a near month option and there is only around fifteen working days to go for the contract ending, and we can fully book profit or when you feel that it won’t go further down. If nifty goes down slowly then also we are benefited we can book profits in the sold call and you have two months time to wait for the other buy to come into profit. Or to say in another way you have net long position in the market with nil or very low capital outlay.
Outcome scenario II
If the market goes up slowly that is an ideal situation for us because our sold call which is near month will be keep on losing its value or coming into profit for us and the buy call will be gaining because it’s the further month and because the market is going up. The only tricky situation is if the market runs up too fast, then we will have to exit the sold call and then sell a further up strike.
I think this is a simple and profitable strategy to operate especially when the market is oversold and when the sentiments are very weak and negative.
About the Author
Science graduate with post graduation in Finance and Management, work experience as a teacher and accountant. Passion for trading and music.
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