Tfyzwdhiqd.pdf

Options Trading

Mathematical Mistakes ‘Option Trading’

Shubham Agarwal, CMT, CFA, CQF, CFTe CEO, Quantsapp

Content

Topics • Objective of choosing Options over Futures • Mistake 1: Holding Options Too Long • Mistake 2: Buying Far OTM Options around Expiry • Mistake 3: Buying Option ahead of Results/Events • Mistake 4: Selling Options Early in Expiry • Mistake 5: Strategy Creation 2

Section 1

Section 1 Choosing Options over Futures

3

A Trading System

A common trading system

4

Trading System

Strategy Backtest Strike rate Total Return Max Drawdown

: : :

50% -2.2% -18%

Call Option is what you need

5

Market

Market Behavior

6

Market behavior

V

7

Option vs. Futures

Options over Futures

8

Linear vs. Non-linear

Long Future Payoff

Long Option Pay-off Unlimited Profit

Unlimited Profit

Profit

Profit

Price -tive Price -tive

Call Option is what you need Price

+tive

Price +tive Limited loss

Loss

Unlimited loss

Loss 9

Enhanced Return Trade on Nifty Target: 100 points

Stop Loss: 20 points

Case 1: Buy Futures

Case 2: Buy Call Option

Target Profit: Rs.7,500

Target Profit: Rs.4,500

Stop Loss:

Rs.1,500

Stop Loss:

Rs.1,500

Margin:

Rs.51,546

Margin:

Rs.1,500

ROI:

14.5%

ROI:

300%

Call Option is what you need

10

Reduced Losses Trade on Nifty ( Gap Down) Target: 100 points Case 1: Buy Futures

Desired Stop Loss: 20 points Actual Stop Loss: 100 points Case 2: Buy Call Option

Target Profit

: Rs.7,500

Target Profit

: Rs.4,500

Desired Stop Loss

: Rs.1,500

Desired Stop Loss

: Rs.1,500

Actual Stop Loss

: Rs.7500

Call Option is what Actual Stop Loss : Rs.1500 you need

Initial Capital

: Rs. 1 lac

Initial Capital

: Rs. 1 lac

Margin

: Rs.51,546

Margin

: Rs.1,500

ROI

: -14.5%

ROI

: -100%

ROI(% Capital)

: -7.5%

ROI(% Capital)

: -1.5% 11

Types of Forecast

Types of Forecast • Bullish – When instrument is expected to increase in price. • Bearish – When instrument is expected to decrease in price. • Eitherways (Volatile) – When volatility is expected in either direction. • Oscillate (Sideways) – When a range-bound movement is expected.

12

Flexibility RBI Monetary Policy

Banknifty may go up 500 points if there is a 50bps rate cut Banknifty should fall 500 points if rate cut does not happen

Call Option is what you need

13

…Flexibility Trade on Banknifty

Direction: Not Sure

If Up: 500 points

If Down: 500 points

Case 1: Trade Futures

Case 2: Trade Options

You can’t buy & sell the same instrument.

Buy a Call & a Put

Call Option is what you need

Combined Premium: Rs.200

Expected Movement: 500 points Actual Movement:

400 points

Profit:

Rs.200 (+ premium)

14

Complexity

Complexity of Creating a Strategy

15

Strike Selection

Strategy: Long Call Forecast Instrument Target Stop Loss Target Days

Nifty 11300 10800 20

Which strike will yield the maximum ROI?

16

Which strike to choose?

17

Multi-Leg

Why choose multi-leg Strategy?

18

Multi-Leg Profits Trade on Nifty CMP: 11000

Direction Expected Target

: Bullish :11300

Case 1: Buy Call 11000 @ Rs.150

Case 2: Trade Strategy : Buy Call 11000 @ Rs.150 : Sell Call 11300 @ Rs.50

Target Achieved: Rs.11250

Target Achieved: Rs.15000

Payoff

Option is what Payoff 11000 Call:Call (11300-11000-150)*75 you need Payoff 11300 Call: (11300-11300+50)*75

: ( 11300-11000-150)*75

Higher Profit

19

Multi-Leg Losses Trade on Nifty CMP: 11000

Nifty falls to 10900

Direction Expected Target

: Bullish :11300

Case 1: Buy Call 11000 @ Rs.150

Case 2: Trade Strategy : Buy Call 11000 @ Rs.150 : Sell Call 11300 @ Rs.50

SL Hit : Rs.11250

SL Hit : Rs.7500

Payoff

Option is what Payoff 11000 Call:Call (0-150)*75 you need Payoff 11300 Call: (0+50)*75

: (0-150)*75

Lower Loss 20

Section 2

Section 2 Mistakes in Option Trading

21

Mistake 1

Holding Options for Too Long V

22

Mistake 1

How much Quantity of Rice you’ll buy?

V

23

Mistake 1

How much Quantity of Vegetables you’ll buy?

V

24

Mistake 1: Example Holding Options Too Long Forecast Symbol CMP Target Stop Reward / Risk Long Call Strike CMP IV Days To Expiry Forecast Evolves in Days Price on Target Price on Stop Reward / Risk

Nifty 10957 11200 10850 2.27 V 11000 105 13% 19 6 233.7966 45.04723 2.148302

Strike CMP IV Days To Expiry Forecast Evolves in Days Price on Target Price on Stop Reward / Risk

11100 66 12% 19 6 161.8023 22.60411 2.207636 25

Mistake 2

Buying Far OTM Options Around Expiry V

26

Mistake 2: Example

Buying Far OTM around Expiry Forecast Symbol CMP Underlying Movement Movement in Points Difference in ROI Long Call Strike CMP IV Days To Expiry Forecast Evolves in Days Price on Target ROI

Nifty 10957 10957 0 45%

V 11000 47.34 13% 5 3 24.09033 -49%

Strike CMP IV Days To Expiry

11200 3.95 12% 5

Forecast Evolves in Days Price on Target ROI

3 0.216731 -95% 27

Mistake 3

Buying Options ahead of Results/Events V

28

Mistake 3: Example Buying Options Ahead of Result/Event Forecast Symbol CMP Target Stop Reward / Risk Price after Result % Move in Price Long Call Strike CMP IV Days To Expiry Normal IV Call Price After Result ROI

V

IDFC 37.5 40 36 1.67 39.00 4%

38 1.48 50% 19 25% 1.47 -1% 29

Mistake 4

Selling Options Early in Expiry V

30

Mistake 4: Scenario 1 Selling Options Early in Expiry Movement Symbol CMP Underlying Upper Range Lower Range

Nifty 10957 11100 11200 10800

Call ROI Put ROI Net ROI

-57.8% 45.7% -12.0%

V

Short Strangle Days to Expiry Call Strike Call IV Call CMP

30 11200 12% 60.44

Days to Expiry Call Strike Call IV Call CMP

25 11200 12% 95.35

Put Strike Put IV Put CMP

10800 16% 130.33

Put Strike Put IV Put CMP

10800 16% 70.72 31

Mistake 4: Scenario 2 Selling Options Early in Expiry Movement Symbol CMP Underlying Upper Range Lower Range

Nifty 10957 11100 11200 10800

Call ROI Put ROI Net ROI

-65.7% 87.7% 22.0%

V

Short Strangle Days to Expiry Call Strike Call IV Call CMP

10 11200 12% 14.97

Days to Expiry Call Strike Call IV Call CMP

5 11200 12% 24.80

Put Strike Put IV Put CMP

10800 16% 53.09

Put Strike Put IV Put CMP

10800 16% 6.53 32

Mistake 5

Strategy Creation V

33

Forecast

Let’s evaluate a Forecast Instrument: NIFTY Target:

? V

Stop Loss:

?

Days:

?

34

Forecast

Which Strategy to Execute? V

35

Forecast

Securitization Strategy Evaluation Steps Calculate the current IV

Calculate the Option Price forV the forecasted day Calcualate the Option Price at Target & Stop * Let’s try this using Option Calculator 36

Strategies- Walk through Bullish

(1) Long Call

(2) Bull Call Spread

(3) Ratio Call

37

Strategies- Walk through Bullish Target comes in 3 days

38

Strategies- Walk through Bullish Target comes in 3 days

39

Strategies- Walk through Bullish SL hit in 3 days

40

Strategies- Walk through Bullish SL hit in 3 days

41

Strategies- Walk through Bullish Target comes in 6 days

42

Strategies- Walk through Bullish Target comes in 6 days

43

Strategies- Walk through Bullish SL hit in 6 days

44

Strategies- Walk through Bullish SL hit in 6 days

45

Strategies- Walk through Bullish Target comes on Expiry

46

Strategies- Walk through Bullish Target comes on Expiry

47

Strategies- Walk through Bullish SL hit on expiry

48

Strategies- Walk through Bullish SL hit on expiry

49

Multi-Leg

Exercise with Multi-leg Strategy V

50

Optimizer

Optimizer Algorithm V

51

Combinations

Did you know??

Possible Combinations

Approx. Scenarios

For Up to 2 Leg Strategy (For e.g. Spreads )

~ 33,670

For Up to 4 Leg Strategy (For e.g. Condors)

~ 18,60,43,585

52

Complexity

Constraints

53

Time Value

54

Volatility

What if Volatility goes down by 25%? What if it goes up by 25%? 55

Other Constraints

Constraints • Capital – The amount of investment in a strategy. For options even the margin system is non-linear.

• Risk – Maximum willingness of risk in a strategy.

56

Other Constraints

• Bid-Ask – The trades gets executed at Bid-Ask which is wide at times. With multi-leg strategies this is of utmost importance.

• Boundaries – Strategies like Ratios, Back-ratios can easily move to infinity and boundaries are important.

57

Data

Data – The Culprit

58

Combinations Trillions of combinations

59

The Solution

60

Optimizer Algorithm

The Optimizer Algorithm         

Prices Data Clean Greeks Forecast Capital Risk Vol Combinations Boundary Conditions Margining System Selection Mechanism 61

How it works

Let’s take an example Direction: Instrument: CMP: Target Price: Stop Loss: Target Date: Reward / Risk:

Bullish Nifty 10957 11100 (+243 pts.) 10850 (-107 pts.) 14-Feb-18 2.27

62

Summary

Summary Options for enhancing Reward to Risk Mistakes in Option Trading  Holding Options for Too Long  Buying Far OTM around Expiry  Buying Options Ahead of Event/Result  Selling Options Early in Expiry Strategy Creation using Payoffs 63

Thank You

64