A lot of traders love to trade Futures. Unfortunately most of them play it un-hedged or naked. Futures is highly leveraged derivatives and has a Delta of almost 1. Which means it moves 1 point with every 1 point move in the underlying. Isn’t this trying to take too much of risk? Remember you are leveraging your money.

Whatever, if done well, rewards are amazing. Futures can make you a fortune pretty soon or can take away all your wealth within months. Unlike options where the losers bleed slowly, Futures will bring results pretty fast.

That is why you will rarely see a Future trader who has lost a fortune. However you will find many option traders who have lost a lot of money in the markets like here and here.

Simple reason is that Futures traders lose a lot of money in 1 or 2 months and then they quit. Option buyers on the other hand bleed slowly. They lose small sums which are not painful, then they get their salary and try again – this time for a recovery – lose some more – next month by luck they recover some money. Then brokers tell them to keep trying, and after years and years of trading they find that they are deep in red amounting to lakhs. By this time their brokers are running all the way laughing to their banks and the trader stops trading frustrated promising never to return to the stock markets. Money Lost – acceptable – Time Lost without any meaningful knowledge is not acceptable. But then it gets too late.

Sometimes it gets so bad that these people do not even invest in any stock or mutual funds. They only invest in bank FDs. That is where they lose even more.

However, there are some who make a lot of money. I was told by a trader who took my course that there are two brothers in some town in Tamil Nadu who are making a killing trading Futures hedged with options. They are making a profit of almost 20-30 lakhs every month on a 1 crore account. Well that works out to a cool 30% return. That does not mean everyone can do it. They must be following a solid strategy and most importantly they are highly disciplined.

We will go to the topic soon but before that let me explain how these brother might have reached there.

1. First they got some education on trading.
2. Then they must have tested a few strategies that their system may have provided or they may have developed themselves.
3. These strategies may have been tested on paper or one or two lots max for at least 6 months.
4. Then once they got a strategy that suits their personality and trading style and also bring in good results – they would have gradually started increasing the lot size of the strategies.
5. And then in few months time, a time comes when you finally see profits of lakhs a month. 🙂

Yep some knowledge, some hard work, and some discipline but see if you are highly disciplined and have a sound strategy making a lot of money from stock markets is not that difficult. But you need knowledge, patience and discipline – that’s the key.

So why am I telling you all this? Because the strategy we are going to learn in this article involves combination of Futures and Options.

The Ratio Put Selling Trade:

When your view is that the stock may remain range-bound, you can:

1. Sell/Write one Future, &

2. Sell/Write two ATM Puts.

Risk vs Reward:

Risk: Unlimited
Reward: Limited

See the image to understand:

As you can see the risk is unlimited to both sides. Frankly I do not like any trade that has unlimited risk. This trade has risk on both sides. In my book its not a good trade.

NOTE: If you have a job or business – taking any trade with unlimited risk is NOT recommended. Why? Because you cannot monitor the markets 9-3. If some bad news comes while you are in an important meeting, a lot of money can be lost. On top of that your broker will call you and the only thing you will tell him at that point is to take the stop loss. By the way at that point what else can you do? But if you were trading full time may be you would have taken a stop loss much earlier. Still I would rather not suggest unlimited risk strategies. The reward is not worth the risk. Stay away. There are better trades. Just search my blog. 🙂 Or other blogs.

In my course the directional strategy is a beautiful combination of Futures and options but the hedge is such that there is no unlimited loss, in fact there is no need to take stop loss as the Max loss is so small that a trader can just leave the trade one full month to hit target. What are the chances that it will hit the target if you leave the trade till expiry? Well a lot.

For example on 6-Apr-2015 I had sold Nifty FUT APR 2015 at 8671.5, after that Nifty rallied almost 200 odd points but I did not take the stop loss as the position was hedged, now I am waiting for the profits to arrive. Even if it doesn’t I am OK as the loss I will take on expiry day will be small. But if Nifty falls even 100 points from here my trade will be in profit. What are the chances? A lot. I still have 15 days to go. 🙂

Lets do a real trade on Ratio Put Selling (Prices as on 14-Apr-2015):

Nifty Spot: 8834.00 (We treat 8800 as At The Money (ATM))

NIFTY Future 30Apr2015: 8855.00

NIFTY 30Apr2015 PE 8800.00: 75.00

The traders view is that Nifty may be range-bound or will fall slightly from here till expiry on 30-Apr-2015. The trader plays the ratio put selling.

Sells 1 lot of Nifty Future at 8855 and also Sells 2 lots of 8800 PE at 75.

Note: In such trades where the risk is unlimited and you cannot stop yourself trading, its highly recommended that you trade in 1 or 2 lots only. If you take a big risk and if Nifty really falls (your view is right) but falls too much suddenly you will have to take a huge loss. On the other hand if Nifty rallies, you still take a loss.

Now lets calculate the max profit and break even points.

The trade makes great profit if the stock stays at around 8800 till expiry or expires exactly at 8800. Lets calculate the profits.

Very Important Tip: Futures premium will vanish and it will show exact price of Nifty spot on expiry day. (This is a great reason to actually short futures and buy the stock in cash. This trade is known as arbitrage. In arbitrage some profits are guaranteed. Its very difficult to find stocks with very high Future premiums, otherwise no one would trade Nifty options. If you can make guaranteed 2% a month by arbitrage what is the need to take risk? The markets makers were quick to realize this so you will see that stock Futures do not have a very high premium. Nifty has, unfortunately you cannot buy shares of Nifty. Someone mailed me and asked if they can do the arbitrage with NiftyBeES. The answer is NO because Each NiftyBeES unit is 1/10th of the Nifty Index value, and Future is 1. So the whole trade will get very complex and unmanageable. If someone reading this has some experience in NiftyBeES please share in comments. Frankly I have never seen or read anywhere traders hedging Futures with NiftyBeES.)

Coming back. Nifty expires at 8800.

Profit from Futures: 8855-8800 = 55 points. 55*25 = 1375.

Both the Put options expire worthless. 75*2*25 = 3750.

Total profits: Rs.5125.00

ROI: Approx 14,000*3 will be blocked. (For each Future and option sell in Nifty approx 14k is blocked)

14,000*3 = 42000 = (5125/42000)*100 = 12.2% in less than 15 days – amazing returns – but it comes with unlimited risk, so trade with caution.

Calculating beak even points:

This is slightly difficult to calculate as two lots of options are sold.

On the up side both the Put options will expire worthless:

So the profits: ((75 * 25 ) + (75 * 25 )) = 3750.

Now the trader can take this as max loss.

3750/25 = 150

8855 + 150 = 9005.

So 9005 is our break even at the upside after this the trade starts losing money.

Calculations:

At 9005 the Future will lose: 8855 – 9005 = -150 * 25 = -3750.

Since both options expire worthless and trader makes 3750 from the put options this trade will break even at 9005.

On the down side:

If 9005-8800 = 205 points was our BE, it should be same on the downside as well.

8800 – 205 = 8595. This is our BE at the downside.

Calculations:

At 8595 the Future will make: 8855 – 8595 = 260 * 25 = 6500.

At 8595 the puts will be in the money:

8800 – 8595 = 205-75 = 130. So a loss of 130 points = -130*2*25 = 6500.

So at the downside 8595 is our break even. Below that the trade starts losing money.

Where to take a Stop Loss in Ratio Put Selling?

We just discussed the break even points – if it is breached you should take a stop loss.

So in the current scenario the trade is safe from 9005 to 8595. Almost 400 points movement. Which means approximately every one times out of 2 the trade will hit stop loss.

Note that both 9005 and 8595 are Nifty Spot prices, not the Future price. Now tell me do you want to trade this?

Note: You may rollover the trade when SL is hit, but whether you make a profit or loss will depend on time taken to hit breakeven and volatility. If volatility has dropped and too much time has been taken to hit BE, on the upper side the trade may be in profit. In that case why should you rollover? On the lower side volatility may not have dropped, in fact increased and since falls are swift, the trade may be in loss. In that case you may rollover.

Conclusion:

• Ratio Put Selling involves One Future Sell and Two ATM Puts Sell.
• It has a unlimited risk and limited reward. Unlimited risk trades need your full attention. Please do not attempt if you have a job.
• Its important that you calculate the break even points and take stop loss when its breached.
• You may rollover the trade once SL is hit. There is no need to rollover if the trade is in profit when SL is hit.

What do you do when you sell Future and its going against you? Do you hedge it or not? Please comment. Your questions and my answers will help other traders reading this.

Thank You.

A lot of times when a stock falls we get an idea that it may not fall further or may remain there for sometime in a range bound region. In such a scenario you can trade a ratio put spread.

How To Trade a Ratio Put Spread?

1. Buy X no of ATM (At the Money) Puts.
2. Sell X*2 (double) number of OTM (Out of the Money) Puts.

See the image below to understand the trade:

Note: If you but 1 lot ATM put, you need to sell 2 lots OTM puts. But this can change depending on your view. For example if your view is pretty strong that the stock may not fall further, you may sell more than double number of puts than the number of puts bought. The point is you are taking a credit. You can sell as many puts you want, but the risk also increases.

For example you can trade buy to sell in this ratio depending on your view: 2:5, 3:5, 2:10 – the combinations are virtually unlimited.

As you can see the 2:5 trade is riskier than the 3:5 trade as more lots are sold compared to the number of lots bought, but if the view is right the 2:5 will make more money than 3:5 trade. Every trade has a tradeoff. 🙂

Risk vs Reward:

Reward is limited to the premium received from the sold options plus any premium got by selling the bought options.
Risk is unlimited if the stock falls.

When to Trade Ratio Put Spread?

When a stock has fallen and your view is that it may not fall any further or may fall 1 or 2% max till expiry.
Volatility does not have much impact in this trade as some Puts are also bought. However profits do increase when the premiums are high as the trader gets a good credit. Usually when a stock falls, the volatility also increases, thus it’s obvious that premiums will be high and you should get a good credit.

Once the trade is done Volatility does not have a huge impact. Because if it falls you make money from the options sold, but lose money from the options bought. However if you have sold more than double the number of options bought, volatility decrease may help the trade. The sold options will make more money than the losses from the bought options.

Note that it’s highly recommended that you DO NOT sell more than double the number of puts bought. Risk is unlimited on the downside. If the stock keeps falling you may have a huge loss.

Where is the Maximum Gain?

On the day of expiry if the stock is exactly at the strike price of the sold options. The sold options expires worthless and the bought options have some intrinsic value – they do not expire worthless and give back some money to the trader.

Which Stocks to Target?

Stocks that do not have huge movement whether they fall or rise. HDFC bank is one such a stock. The idea is if the stock does not move – you should make a profit in a few days and exit the trade. Do not wait till expiry.

Lets take another example. Reliance Ltd. Recently the stock has fallen a lot and your view is that it will remain here or increase slightly in the next one month.

(Disclaimer: This is a virtual trade. Please do not copy. If you want to trade, please trade at your own risk.)

See the graph:

See that the stock has fallen a lot since the last one year and you think that it may not fall further. You trade the ratio put spread on Reliance.

Now let me get real prices of Reliance Puts.

RELIANCE 30-Apr-2015 PE 820.00 16.00 (ATM Put)
RELIANCE 30-Apr-2015 PE 800.00 9.00 (OTM Put)
1 lot = 250

Buy 1 lot 820 PE = 16*250 = 4000 (Debit)
Sell 2 lot 800 PE = 9*250*2 = 4500 (Credit)
Note that 4500-4000 = 500 is NOT max profit.

Now if on 30-Apr-2015 the expiry day, Reliance is exactly at 800 (the sold Put strike price) this trade will make max profit.

The 800 PE expires worthless = 4500 Profit.
The 820 PE will be at 20 = 20-16 = 4*250 = 1000 Profit.
Total Profit: 4500 + 1000 = 5500.

The trade made profits from BOTH the sold and the bought options.

Calculating ROI:

Approx Rs. 52,500 will be blocked. (5500/52500)*100 = 10.47%.
This is a great ROI.
If stock is above 820 on expiry day, which is highly likely, I still make Rs. 500 profit – a 0.95% return.

Lets take another example on Nifty.

30-Apr-15 PE 8,500.00 120.00
30-Apr-15 PE 8,400.00 85.00

Buy 100 8500 PE: 120 * 100 = 12000.00 (Debit)
Sell 200 8400 PE: 85 * 200 = 17000.00 (Credit)
Total Credit = Rs. 17000 – 12000 = Rs. 5000.00

Max profit calculation:

Nifty at 8400 on expiry day (the shorted put strike):
8400 Puts expire worthless: 17000.00 Profit
8500 Puts at 100: 100 – 120 = -20*200 = -4000 Loss
Total Profit = 17000 – 4000 = Rs. 13,000.00

ROI:

Margin Blocked: Rs: 1,08,000 approx.
(13000/108000)*100 = 12.03% return in 30 days.
Even if Nifty is above 8500 the trader makes Rs. 5000, approx 4.6% return in 30 days.

Yes Nifty gives more return than stocks for the same trade. The reason is the premium of the options vs. the margin blocked. To attract traders to trade in indexes the market makers make sure the premiums in the index options is better than the stocks, on top of that due to lower risk less margin is blocked. That is the reason why you see more option trading happening in index than stocks. This is true for all the stock markets in the world.

Calculating Break Even:

If you are getting a credit trading put ratio spread, there is no need to calculate the upper break even. If you are paying a debit you may have to calculate the upper break even as well. However since this trade is mostly done on a credit lets calculate the lower break even on the Nifty trade.

Since the break even will depend largely on the points received and paid you may need to calculate your break even every time you trade.

In our case it is 150 points below the sold put strike.

8400 – 150 = 8250. If Nifty is at 8250 on expiry day:

Buy 8500 PE is: 8500 – 8250 = 250-120 = 130*100 = 13000 profit.
Sold 8400 PE is: 8400 – 8250 = 150-85 = -65*200 = -13000 loss.

Hence if Nifty is at 8250 on expiry day, this trade will be at break even. Below 8250 it loses money.

What is the risk in the trade?

If Nifty keeps falling the extra options sold on the 8400 strike will increase in value and start making losses. Remember these are not hedged so losses can be unlimited. Therefore to restrict losses it is important to take a stop loss exactly at the strike price of the puts sold. If you leave and Nifty reaches 8000 – you may suffer heavy losses.

How to increase the return?

If you are a technical analyst you can sell the puts at the support level strike. However there is no guarantee that the stock may not fall further.

If volatility is VERY HIGH and you assume after the news it may crush, then you can sell more than double the number of puts you bought. However please do not increase the buy : sell ratio of 1:3 – means 1 put buy and 3 puts sell.

If volatility gets crushed after the news, you can immediately realize a good profit and square off the position. It does not matter even if the stock moves down slightly after the news is out. The volatility crush will help the sold puts and since you have sold more than you have bought, the whole trade will be in good profit in only few days.

It gives the best return on expiry day. Should we wait till expiry?

Traders waiting till expiry are trading a bad strategy. No trade should be done to be taken off on the expiry day. Profit or loss should come much before to expiry day. That predetermined profit or loss should be there in your mind when starting the ratio put trade. Once its achieved exit and look for another opportunity.

Conclusion:

1. Ratio put trade is done when the trader thinks the stock may rebound or may not fall further.
2. It is done by buying ATM put and selling double the number of OTM puts.
3. If stock is at the short put strike on expiry day maximum profit is achieved.
4. If stock is above the bought puts still some profits can be made.
5. If stock keeps falling the trade can lose a lot of money, so traders should take a SL when the stock has reached the short put strike to limit losses.

Have you ever traded ratio put spread? If yes let us know what happened in the trade.

You can download the PDF version of this post here.

Stock market investors in India and around the world want to make a lot of money by investing. That is the sole reason they invest. Else there is no reason to take a risk. Most of us want to make one crore or millions of dollars from the stock markets.

Well good news is its not that difficult to make one crore. In fact you can make crores. The bad news is you yourself is your biggest enemy of your own investing. Our own self-destructive speculative trading and the mindset to get rich quick from the stock markets is the biggest obstacle to make crores from the stock markets.

Another problem is that investors do not diversify their portfolio. When I talk with traders like who lost 2 crores or even lakhs, I found out that the real problem is greed & ego. The feeling that “I can do no wrong with my investments” and “the markets will favor me” is a grave mistake of investment. Why should the markets favor you? Because you want to get rich quick? Is that a valid reason?

However if you trade cautiously, take calculated risks and trade very conservatively, you can accumulate huge wealth over the years trading the stock markets. Mind it we are talking about accumulating wealth over the years and NOT days or months. This is possible only through conservative trading and NOT aggressive trading. You may want to check out my conservative options trading course where you can learn such strategies to make money slowly but consistently in the stock markets. It is doing good for a lot of traders all over India.

A few days back I got another dreaded email: (Sender’s name withheld for privacy. Edited for grammar and spelling.)

I am a heavy loser in share market. In the last 25 years I lost about Rs. 25 lakhs. I lost a huge amount at the time of Harshad Mehata scam. After every three four years gap I collected two or three lakhs from my very hard earned money and lost in share market in hope that one day I will be winner. May be this was due to ego that one day I will be a good trader. I want to take one more last chance, with rest of my remaining capital of 1 lakh.

Which software will be required for me to achieve the above target? Do you know any good tip provider to fulfill my requirements? I can’t lose more then 10% of my capital, and when I lose 10% I will quit from market. I have also spent a lot of money on a lot of trading software and tips providers.

Is there any kind of hope for my kind of student?

The first thought that came to my mind was there is no hope for this kind of trader because even after losing for 25 years, he just wants a software or a tip provider to help him make money. He does not want to learn anything. If you cannot help yourself how can you expect a software or a tip provider to help you?

What a waste. No I am not talking about money, but TIME. Rs. 25 lakhs is NOT in any way bigger than 25 years. When I asked this trader what have you learned in your 25 years of trading, the answer was shocking. He we silent. Which means he learned nothing in the last 25 years. This is sad. If you are passionate about something – go into details to learn about it.

The last thing you should do is keep trying the same thing again and again without any research or knowledge. If you do the same mistake every time, how can you expect a different result every time?

How many of you reading this are doing the same investing mistake again and again thinking that this time the outcome will be different? I bet if you haven’t learned anything and are still speculating, you will get the same result every time you trade. You will waste time and money. After years you will feel guilty about what you did with your money. Please don’t let that happen to you.

When I asked him why he kept repeating the same mistake, he said he feels sad about it now. He said he wanted to get rich fast and kept trying the same thing. He has also hinted in his email that it got into his ego to beat the markets. Well emotions don’t work in stock markets. They do not know you.

I then told him he could be worth 500+ crores today – repeat 500+ crores of rupees – had he not done those mistakes with a only paltry investment of a few thousands rupees 25 years back. He was shocked. He asked me how. I know you also want to know how?

Lets discuss. 🙂

Imagine a stock investor bought 1000 shares of ITC ltd. at Rs. 10/- in 1975. Total investment amount = 1000 * 10 = Rs. 10,000/ -. He met with an accident and went into coma.

Agreed this is a very unlikely situation, but for now lets believe it. Please note that Rs. 10,000 is NOT a very big investment even in the year 1975. Calculated at 9% inflation rate, at today’s value it is equivalent to Rs. 314,094.20. If 3 lakh is not a very big amount today, 10,000 would also be not that huge 40 years back, but still significant.

Lets get started. The investor is in comma and this is what happens when he is sleeping:

1975 – Bought 1000 Shares of ITC Ltd. at Rs. 10 per share. Total investment amount Rs. 10,000.00.
1978 – ITC issues share bonus 1:5. Current shares: 1000 * 5 = 5,000.
1980 – ITC issues share bonus 1:5. Current shares: 5000 * 5 = 25,000.
1989 – ITC issues share bonus 1:1. Current shares: 25000 * 5 = 50,000.
1991 – ITC issues share bonus 2:5. Current shares (50000*5)/2 = 1,25,000.
1994 – ITC issues share bonus 1:1. Current shares: 125000 * 2 = 2,50,000.
2005 – ITC issues share bonus 1:2. Current shares: 250000 * 3 = 7,50,000.
2005 – ITC declares share split 1:10. Current shares: 750000 * 10 = 75,00,000.
2010 – ITC issues share bonus 1:1. Current shares: 7500000 * 2 = 1,50,00,000.

1000 shares convert to 1.5 crore shares.

Lets assume the investor got cured from comma and was perfectly OK last month and suddenly realized he had invested Rs. 10,000.00 in ITC in 1975.

He calls his broker and asked him to sell all shares in his account. ITC shares reached 390+ last month.

390 * 1,50,00,000 = 585 crores. Assuming that more than 215 crores dividend was also given.

Total profits = 585 + 215 = 800+ crores on an investment of just Rs. 10,000. Remember all this is TAX FREE because any investment in shares for more than 1 year is not taxed. Dividends from shares is also not taxed.

Compare this to a bank Fixed Deposit: Investment of Rs. 10,000.00 in 1975 re-invested with interest as soon as it got matured every year for 40 years today would be worth only Rs. 3,14,094.20. A little more than 3 lakh rupees. I have not even deducted taxes. A fixed deposit in bank of any amount for any period of time is taxed. So the investor will be left with less than Rs. 3,00,000.00 (3 lakhs). Poor returns.

(That does not mean you should never invest your money in fixed returns. Some money should go to very secured financial instruments, just for diversification of portfolio. Stock markets are volatile – you may need some money very soon – this should be in fixed income instruments. Click here to read how I diversify my portfolio. If you are young, most of your savings should be invested in stocks of good companies.)

Another example:

Had your relative invested in 100 shares of WIPRO at a price of Rs. 100/- per share in 1980 and forgotten about it – this is what would have happened to his account. (Note that unlike ITC shares, WIPRO shares are being bought at a premium.)

Total investment: 100 * 100 = Rs. 10,000.00
1981 – WIPRO declares bonus 1:1 = 100 * 2 = 200 Shares
1985 – WIPRO declares bonus 1:1 = 200 * 2 = 400 Shares
1986 – WIPRO declares split 1:10 = 400 * 10 = 4000 Shares
1987 – WIPRO declares bonus 1:1 = 4000 * 2 = 8000 Shares
1989 – WIPRO declares bonus 1:1 = 8000 * 2 = 16000 Shares
1992 – WIPRO declares bonus 1:1 = 16000 * 2 = 32000 Shares
1995 – WIPRO declares bonus 1:1 = 32000 * 2 = 64000 Shares
1997 – WIPRO declares bonus 2:1 = 64000 * 3 =192000 Shares
1999 – WIPRO declares split 1:5 = 192000 * 5 = 960000 Shares
2004 – WIPRO declares bonus 2:1 = 960000 * 3 = 2880000 Shares
2005 – WIPRO declares bonus 1:1 = 2880000 * 2 = 5760000 Shares
2010 – WIPRO declares bonus 3:2 = 5760000/3 = 1920000*2 = 3840000+5760000 = 96,00,000 Shares

100 shares of WIPRO became 96,00,000 (96 lakhs) Shares in 2015 (or in 35 years).

WIPRO is currently trading at around 650.

650 * 9600000 = 6,24,00,00,000.00 OR Rs. 624 crores. 🙂
Dividends = Rs. 200+ crores
Net Worth = 624 + 200 = Rs. 824+ crores.

Profit of more than Rs. 824 crores by a throw away paltry investment of just about Rs. 10,000 in 35 years without doing any hard work. How is that for a return? Most people do work for 30-35 years. Someone who had done that could have retired now with worth more than many rich industrialists/entrepreneurs in the world. 🙂

Had you father invested in shares worth even Rs. 1000/- (one thousand only) in your name in 1975 in ITC or WIPRO, you would be owner of many of crores today. 🙂

Now the first question that may come in your mind is, how can we know that a stock will give such a return in a few years time. Good question. But the fact is almost all big companies returned almost the same amount. Mid-caps were better. May be you would have made 100 crores with some other company but does that really matter?

What about diversification? Some in ITC, some in SBI, some in HDFC etc? What about more investments every year along the way? Can you get the idea I am talking about? By the time you retire you will have accumulated so much wealth that not only can you live very rich life but you can pass this great wealth generated to your children and/or grandchildren.

There is a living person who invested in stocks using the same strategy above and made billions of dollars. He is none other than Warren Buffett. He is probably the most successful stock market investor of our time. He is also one of the most riches man walking on Earth today. Stock markets made him rich but it was not overnight. It took him years of investment. Once some reporter asked him what was the best time to sell a stock? His reply was NEVER.

Yes it took him a lot of years to become very rich, but how you want your investment to perform 10 years from now? Ask yourself.

How to make crores from the stock markets now?

So you want to know how you can repeat the same performance now? Answer is the same. Something that does not make money will never make money and something that does make money will make money. This theory will hold true years from now.

You need to identify stocks that you want to invest into and keep investing into them till you retire. Choose 5-6 great companies and start investing today. Forget this money till you retire.

Of course diversification also means not investing everything in just one place. What if your stock portfolio does not perform? For that you must trade as well – but trade conservatively. If you are conservative with your trades you should be able to make money over time. Even a 20%-30% return a year is much better than speculating options and losing money. Results can be great if you compound that money. We are talking 10 years from now, not tomorrow.

With stocks you do not have control over price. With trading options conservatively, you have.

Your age is running out. If not now then when?

I got this comment from Mr. Noble which I think is quite interesting so I am posting both the comment and my answer here to benefit all. Most people do not read comments.

It is possible to speak these ideas from hindsight. The markets have matured and we are not in 1975. Investments now requires a different kind of approach. This may not work as we are in a different market cycle. Also cycles can not be identified beforehand. The companies existing today may not be around in another 30 years.
Thanks,
Noble

My answer:

Noble,
You are absolutely right the markets have matured and we are not in 1975. But that stands for every business. If you want to start a company – you need to just jump into it with some research and money. A lot of people have ideas to do business but will give themselves excuses like – today’s economics is different than what is was 20 years ago, there is a lot more competition blah blah. These are the people who never are able to start a business and in spite of being intelligent, die working their life in a 9-5 job. Had they not given themselves any excuse and given it a try for at least 1 year – I am sure most would succeed.

The point here is if markets have changed why can’t you?

The biggest change that has happened is that today shares and even IPO (Initial Public Offering) are sold at a premium.

So if a great company like ITC or WIPRO comes with an IPO today it would be at least in the price band of Rs. 300-350 per share. But if you count inflation, going 30 years back probably Rs. 300/- would be equal to 23 – double that of 10. So maybe not 800 crores, but you make 400+ crores – does it really matter?

Yes it’s difficult to pick companies that will keep growing for years, but it’s not difficult to pick a few that are doing very strong today. Keep investing in them for a few years, and when you make a healthy profit – take your money out. Then according to those times pick another set of great companies and start investing. Rotate your money and compound. 🙂

It is not that difficult. For example I lost money from 2007 through 2011. A lot of investors lost too. My psychology was exactly the same on the lines of what you have written. It’s a different market, it’s hard to find great companies to invest blah blah – the result I lost money because I had no discipline or a planed approach to investments. And I wanted quick results. You have to learn to live with the volatility of the markets.

Let us take an example. At that time IT and banking sectors were doing well. Had I invested gradually in Axis Bank, SBI, and Infosys (all giants) – my investment would have grown by at least 500% – this in just eight years.

So stop giving excuses. Just start investing. I bet in a few years time you will see the benefit.

Do you invest directly in stocks? If yes let me know which stocks you invest and how you plan your investments. Your comments will help many investors reading this blog.

Thanks.

You must have got some idea about ratio call write strategy by the name itself. Basically it is selling options against futures or stocks. Frankly these kind of positions work only if your view is right else there can be unlimited losses.

Whenever in any trade there is a chance of unlimited loss, I get uncomfortable. Though I agree at some point we will take the losses out by getting out of the position, but the potential damage it can do by that time is unknown. Since the damage is unknown, I usually do not get into these kind of positions. Actually its in-built now, all these unlimited loss trades or speculative trades does not exist for me.

But ratio call write trade is one of those better trades, and I feel if this article helps traders looking for ratio call write trade, then that would be great.

Ratio Call Write is somewhat like a covered call but comes with a slight twist. Covered calls are usually done on stock vs. options i.e buy stock and sell call. However buying stock and selling call is not unlimited risk. Here we will see why a similar trade is at unlimited risk.

The View:

The view of the trader is that the stock will stay in range for the next few days and the volatility will fall. Even if the stock falls or rises by a couple percent points the trader may close this trade for a profit.

How To Trade The Ratio Call Write Strategy:

Buy X Lots in Nifty Futures / Stock Futures or Stock in Cash
Sell 2*X Lots ATM (At The Money) Call Options current month

Which means if the trader buys 1 lot of Futures, he needs to sell 2 lots ATM Call options. If he buys 2 lots of futures, he needs to sell 4 lots of ATM call options.

Note that in covered calls only the same number of ATM/OTM call option is sold, but here the trader sells double the number of call options.

You must be thinking this is a better trade than the covered call because not the same number but double the number of options are sold, but you will be surprised to know what may happen. In short, if risk is concerned, covered call is a better trade than ratio call write.

Risk vs Reward:

Risk is Unlimited and Reward is Limited.

Look at the image below to understand the risk reward of Ratio Call Write trade better:

Now let me do a real paper trade to help you understand better how you will make profits and how you may incur losses.

Date: March 10, 2015
India VIX: 15.53
Nifty Spot: 8700.00

Buy 1 Lot Nifty Future: NIFTY 26Mar2015 Future: 8772.00
Sell 2 Lots of 8700 March Call Option: NIFTY 26Mar2015 CE 8700.00: 160

Credit Received = 160 * 2* 25 = Rs. 8000.00

Note: None of the other websites which teaches the Ratio Call Write Strategy will tell you the hidden price of Futures while explaining this trade. As you can see even though Nifty Spot is 8700.00, a trader has to pay a premium while trading Futures.

Though Nifty is at 8700, the Future is traded at 8772. A difference of 72 points. Mind it, this is a significant issue and cannot be ignored. This can significantly impact the profit and loss of the trade.

Therefore its highly recommended that this trade should be done in cash holding of a stock. Yes you may need a lot of money to trade this with real stocks in your Demat account, but it will be less riskier than doing it with Futures.

If you are thinking why you need to pay a premium to buy/sell futures than the answer is Volatility, Time and prevailing Interest Rate. By trading in Futures you are getting a leverage. 8700*25 = 217500. You need this much cash to buy Nifty 1 lot if Nifty was a stock. But by buying a Future you are getting the same benefit if the Nifty appreciates. And how much cash is blocked? Approx 14,000. Which means you are saving more than Rs. 2 lakh per trade. Who will pay for the interest earned on that money? The Future trader, in the way of premium.

Also, it is not justified if someone buys a stock by paying the full in cash, and someone buys a Future by paying just 10% of it – and make the same profit in the same movement. There should be some justification. Therefore the Future trader pays a premium. Of course on the expiry day both the Future and the stock will show the same price.

Well do you know the above situation can be traded as an arbitrage? For example if Future of a stock is trading at a huge premium, you can sell Future and buy the stock at the same time. Now this is a guaranteed profit for you. For example if Future is trading at 105, and the stock at 100. You can sell Future and buy stock and on the expiry day if the stock is at 100 – you can make 5 points from Future. If the stock is at 105, you make 5 points from the stock. 🙂

Excited? Well don’t get too excited because markets are priced in such a way that arbitrage opportunities are rare now a days. But if you search seriously you may get a couple of trades every month. One day I will write on arbitrage trades, but for now lets leave it.

Coming back to the trade.

Now imagine a situation where Nifty did not move much and stayed at around 8700. See how the Futures will eat into the profits.

Both the lots of 8700 March Call Option will expire worthless. The trader gets to keep Rs. 8000.00.
BUT Future will also be at 8700. Loss from Futures 72 points. 72*25 = 1800.

Total profits: 8000 – 1800 = 6200.

Imagine Nifty to be a stock and also imagine the trader buying Nifty shares at 8700. Now he is at zero loss from the shares, but full Rs. 8000 profit from the call options sold. With futures the premium he paid has gone. Imagine losing this money trade after trade plus the times he made a loss. Future premium will only add to his agony every time he trades this.

Hope its clear that if the stock does not move, the trader will make profit in the Ratio Call Write strategy. Do you really think for a period of 30 days Nifty will not move? No that is not going to happen.

Now coming to the difficult situations. The trade break even is option premium received from selling the calls on the lower end and profits coming from the Future covering the loss till break even is reached, on the upper end.

In the lower end it is: 160 * 2 = 320.
Lower end break even: 8772 – 320 = 8452

Why we are considering the Futures price, why not Nifty spot? Because your profit and loss will be calculated on the Future price NOT the Nifty spot when you initiated the trade.

Calculations when Nifty falling down and on expiry day is at 8452:

Loss from the Futures: 8452 – 8772 = -320 * 25 = -8000.
Both the sold call options expire worthless: Profit = +8000.
Total profit or loss: 8000-8000 = 0.

Which means break even on the downside is 8452. If Nifty keeps falling even after reaching 8452, the trader is at unlimited loss.

Lets calculate break even on the upside:
Calculating this is a bit tricky as we have two sold options, not one. Remember the max loss that can be covered is 320 points but there are 2 options so break even on the upper side is: 320/2 = 160 + 8772 = 8932.

Calculations when Nifty is at 8932 on expiry day:

Profit from the Futures: 8932 – 8772 = 160 * 25 = 4000.
Loss from the sold call options: 8700 March Call Option will be at: 8932-8700 = 232.

((160-232) * 25) * 2 = -3600

Total profit or loss: 4000-3600 = 400. (Note that on the upper end it is very difficult to get a zero profit or loss because there are two options sold, so the loss multiplies by 50 but the profit multiplies by 25.) Still consider this as break even.

Which means break even on the upside is around 8932. If Nifty keeps going up, the trader is at unlimited loss.

Which Calls to Write?

Best is to write ATM calls expiring in next 30 days because they have little time value. If stock does not move much even for a few days the erosion of premium of the sold options will be significant as they are ATM and the trader can exit in profits.

When to Book Profits?

It depends on the comfort level of the trader, but as a conservative trader for me 2-3% per trade is good enough. Whatever, never wait till expiry, any day you see a good profit just exit.

Why Ratio Call Write strategy is better than buying/selling naked futures?

Many Reasons:

1. There is a big room for profit: In the above trade the room is from 8944 to 8464. If Nifty is anywhere between this on expiry day the trader can be in profit.
2. Whether Nifty goes down or up the trader will feel safe at least until 8944 or 8464 gets breached.
3. If some time passes and Nifty has fallen only a few points the trader can still exit in profits, because the time will eat some premium from the options sold.
4. This is not trading in a panic state of mind. Though not conservative, this trade is still better in terms of keeping stress under control.
5. Still this trade is a unlimited loss strategy so at least I do not recommend it. However if you own real stocks (not Futures) this trade can be traded. Because if the stock falls or does not move the trader makes great money. However if stock keeps rising, the trader can exit one of the call option at a small loss and convert this trade into a covered call.

Conclusion:

• Ratio Call Write is a strategy where traders owns stock or futures and sells double the lots of call option against the no of lots of Futures.
• The idea is to take profits from the sold high premium ATM options.
• If stock rises, the trader needs to take stop loss in the calls sold or exit the trade altogether.
• If stock falls the trader can book profits in the sold options and can again sell the options of next month.
• There is a big room for profit in this trade.
• Unlimited risk, so be careful. Calculate your break even points both sides and get out if breached.

Have you ever sold 2 call options against Future buy? If yes please tell us your experience.

In my last post I discussed 7 reasons why you should not trade on budget day.

Look how these words came true from that post:

Nifty will move swiftly up and down as the budget speech progresses. One good news and Nifty will jump 25-50 points, one bad and it will dip 50-70 points. You can never predict the direction of the markets that day. However watching Nifty dance will be fun if you are not trading. Moreover since Nifty will move very fast it will be hard to trade.

In this post I will analyze what may have happened to Intraday traders on the Budget Day. Look at the image below. See how Nifty danced:

Photo credit: moneycontrol.com

On 28-Feb-2015, the budget day Nifty opened at 8913.05, went to a high of 8941.10, hit a low of 8751.35 and closed at 8901.85.

From low to high the points difference is: 8941.10 – 8751.35 = 189.75. In terms of percentage it is: (189.75/8751.35)*100 = 2.17%. It looks small but see how Nifty danced from 8900 to 8840 to 8900 and then again back to 8840, then hit a low of 8750, then back to 8840, then again back to 8900 – closing almost flat since the days’ opening. All this in few hours.

Its not about budget, but any day when a big news is being declared Nifty will behave like this. This makes life difficult for Intraday traders. For positional and conservative traders however this movement means nothing.

Turnover was Rs. 10,064.41 crores. On normal days the turnover is around 6,000-7,000 crore. That’s more than 40% increase in turnover.

Such an increase in turnover on a single day is a proof that there was too much of Intraday trading. You can easily guess that most of them may have lost money.

On top of that India VIX dropped 13.29% from the previous day’s closing. It dropped to 16.97 from 19.57. (Read my previous article, I had mentioned that VIX will drop). Dropping Vega means the option premium will not appreciate well even if Nifty appreciates. It means most option buyers may not have made money.

All those who made some money had to time Nifty well. This means taking a contrarian call. They must have bought ATM Call option when Nifty was at around 8800 and sell it when it went back to 8900 levels. How many traders can do that?

Intraday traders mostly want to go with the trend. They do not go against the trend.

Which means when Nifty went up they must have bought calls, hit stop loss when Nifty was around 8750, then they must have bought Puts, but Nifty again changed trend, hitting stop loss in Puts again.

This is a guess, but this is what happens with Intraday traders during most trading days.

With option sellers (though only a small percentage of Intraday traders are option sellers), the problem may have been more psychological than technical. Imagine selling options and taking unlimited risk for a limited unknown profit on the budget day. I do not think anyone should do that. Just thinking selling naked options on a budget day makes me nervous. I do not have that guts.

Of course if you hedge your positions then profits and losses both are limited and that takes fun out of Intraday trading on such a huge day. I am sure most of them did not hedge their positions. And lost money. 🙂

Some Intraday players trade on budget day just to satisfy their egos. They know fully well the dangers involved, but still trade. If they make even 1 point profit they feel great. But then they take a large position only to lose more than they made. Egos don’t work in stock markets.

If you are also an Intraday trader, I urge you to stop trading Intraday as soon as possible. You will only make your brokers rich. You will lose money trading Intraday, if not you can never compound Intraday trading with large positions. Even if you are a smart Intraday trader, your profits will not be significant even years from now.

Have you heard of any Intraday trader supporting his family from his trades or increasing his wealth through Intraday trading significantly over last decade?

Did you trade Intraday on the budget day? If yes what was the result?

Being a conservative trader I do not trade on big news days like Budget. 2015 Financial Budget is on 28-Feb-2015, a Saturday. For a conservative trader like me it is NOT an ideal situation to trade. Even though a holiday the markets will remain open for live trading. I do not care, for me big news days are trading holidays.

I think the brokers lobbied and got SEBI (Securities and Exchange Board of India) to let them do their business on a trading holiday. This is one day they make a lot of money. They didn’t want to lose a great money making opportunity this year.

Here are 7 reasons why you should not trade on Budget days:

(This holds true for any big financial news announcement days.)

1. Volatility will be very high: Nifty will move swiftly up and down as the budget speech progresses. One good news and Nifty will jump 25-50 points, one bad and it will dip 50-70 points. You can never predict the direction of the markets that day. However watching Nifty dance will be fun if you are not trading. Moreover since Nifty will move very fast it will be hard to trade.

2. Margins will be blocked more: Most brokers will not allow normal margin blocking rules on Budget days. I think for Intraday, most brokers will NOT allow MIS trading in equity cash, so 100% cash or full margin will be blocked. Which means if you select MIS to trade equity, the orders will be rejected due to margin requirements or they will block full margin if you have cash in your trading account.

In F&O & Commodities, NRML or full margins will be blocked too. Any MIS order will be outright rejected or NRML equivalent margins will be blocked.

Cover orders will not be available for trading. Cover orders are orders that enjoy even less margin requirements than MIS for Intraday because the trader has to compulsory put a stop loss in the system while placing the order. This stop cannot be changed when the order is triggered. All orders are executed at market. Since the losses are taken care by the system, the margin requirement reduces.

So why cover orders are not allowed on budget days if the stop loss is compulsory? Because stocks or index may jump and the stop loss may not get triggered and if the stop loss is a market order (not limit order), then the trader may incur huge losses. Your broker do not want this. They know if you lose a huge amount of money in a single day you will stop trading and they will lose one valuable client. Their business can get affected.

Moreover if you incur huge loss and you do not have money in your account then the brokers will have to give you a margin call. This is a cumbersome process for them. Imagine if 200 clients lose 1 lakh and they have only 50,000 in their trading account. Their total loss is 2 crore, but the money with the broker is only 200*50000 = 1 crore. This means in 2 days time the broker has to arrange Rs. 1 crore, to be given to NSE/BSE, from the clients who lost money.

What if most are unable to pay? In that case the broker will have to pay money to NSE/BSE from their own pocket. They might even lose their brokerage license because their risk management team failed to manage risk of their clients. This is a big risk for brokers, so cover orders or MIS are not allowed on budget or big news announcement days.

Which means your broker will love you if you trade but hate to give margins on Budget days.

Of course if you are not trading Intraday or taking positional trades, there will not be much of a difference.

3. Risk Reward ratio is not good: Higher margins, more risk, less reward. Risk reward ratio will not be in your favor. More money at risk, less profits is not attractive for any trading business in the world.

4. Limit vs. Margins: On that day if you hit market order you will NOT get a good price because of the jumps, and if you do a limit trade you will not get a good trade fill fast. You may have to wait longer and in frustration you will hit market just to trade. This is like forcing yourself to trade. A forced trade is sure to lose money. Not good.

5. Volatility will crash: This is good for option sellers, but delta can kill them. If the stock moves very fast against their option, volatility crash will not be of much help – delta will do the damage. Option buyers will see the option prices not moving fast enough because Volatility will drop. Therefore its not a good day to trade for both sellers and buyers.

6. You will get frustrated: End of the trading session most traders will be frustrated because things will not go as they planned.

7. Money will be lost: This is true for 90% of the traders. Because of all the factors above it is most likely you will lose money trading on the budget day. Save you money to start trading from next day.

All in all the traders’ ego gets busted, money is lost and the day is destroyed.

I suggest just watch Budget on TV and relax with your family. Do not destroy your holiday because of the budget. After the budget is out you will have some idea of where the markets will head for the next few days – you can then chose to take a conservative directional call.

I have got out of all of my F&O positions and I hope you get out too. I sincerely hope you will not trade on budget days. Lets leave greed for one day. 🙂

Remember that only 10% of the traders will make money, the rest will lose. Being my website visitor I do not want you to lose money on that day. This is my humble request. Rest its your money and decision.

Here is copy of email I wrote to my email subscribers one day before budget requesting them not to trade:

This is a reminder that please DO NOT trade tomorrow. Volatility will be very high and constantly dropping and its not good for option buyers. Sudden jump may prove dangerous for option sellers as well.

Here is one real example: On 26-Feb-15 (yesterday), Mar 9500 CE closed at 11.45 Nifty at 8685. On 27-Feb-15 (today), Nifty closed at 8845 and Mar 9500 CE closed at 14.85.

VIX dropped by 4.91%.

As you can see the danger has already started. Just a small drop of 4.91% made sure a huge 160 points jump in Nifty had very minor increase in the OTM options. Of course you can argue that ITMs have appreciated, but then the money you pay to buy will not justify the risk reward ratio.

If you insist on trading tomorrow, please at least do a credit spread. Which means buy at ATM and sell OTM. This will highly restrict your losses, of course profits will get restricted too.

Do not short naked options tomorrow. If you want to short then, short one and buy 2 OTM options.

Trade Conservatively.
Thanks,

Trade Conservatively & Be Happy.

In this post we will learn how to trade the short ratio call spread.

This strategy is traded when a trader has a range-bound view on the stock, but feels that the volatility will decrease in the near future.

Creating the Short Ratio Call Spread:

1) Buy 1 In The Money (ITM) Call Option
2) Sell 2 (or double the number of) Out Of The Money (OTM) Call Options

Note: Refer my article on long call ladder. You will see that in the long call ladder a trader buys one ITM call option and sell one ATM call option and another OTM call option. So what is the difference between long call ladder and the short call ratio trade?

The difference is the credit received and risk in the trade. While in the short ratio call spread the credit received is more, in the long call ladder the credit received is less. Risk is also more in this strategy than the long call ladder because the shorted options are near the money.

Risk vs. Reward:

Risk is Unlimited.
Reward is Limited.

Look at the image below to understand better:

Lets now trade Short Ratio Call Spread using real premiums.

Date: 23-Feb-2015
Nifty spot at 8755
INDIA VIX: 21.63

26-Mar-15 CE 8,800.00 213.00 (We will consider this OTM Call Option)
26-Mar-15 CE 8,700.00 266.00 (We will consider this ITM Call Option)

Please note that on the day I was writing this article (23-Feb-2015), VIX was on the higher end so you are seeing such high premiums for at the money options. You may get slightly lower premium when you trade. The higher premium is also due to Budget 2015 which will be declared end of this week.

Lets now trade this using the above premiums. To make math simple we trade 100 shares.

1) Buy 100 ITM Call Option: 266*100 = Rs. 26,600.00 (Debit)
2) Sell 200 OTM Call Option: 213*200 = Rs. 42,600.00 (Credit)

Total Credit: 42600-26600 = Rs. 16,000.00

Note: If you do not go far or deep out of the money, ideally you should get a credit. But risk will also increase. Remember if Nifty keeps going up, this trade will have unlimited loss. So the selection of the strike to short is VERY CRITICAL to the success of this trade.

On the one hand, if you sell the nearest OTM option, you get a large credit, but your risk on the upside is very close. On the other hand, if you go deep out of the money and sell options far away then you may not get a credit and may have to pay cash to trade this. In this case the risk reduces, but reward also decreases.

So Which Strike To Sell?

If you sell options very close out of the money, you are actually taking a bear call. Like in the example above. The trader has got a large credit – so he will be happy if Nifty falls.

If you sell options far out of the money, you are taking a slightly bullish call. Since you paid money to trade you want to profit from both the bought options (for that Nifty has to rise), and the sold options (for that Nifty cannot travel far up). So you would want Nifty to go up slowly.

Therefore I suggest you sell options that far so that you pay a very small amount or get a small credit. This will balance out the bear and bull view and be correct with the strategies view which is range-bound with fall in volatility.

Can you smell the benefits of being a conservative trader? By selling not very far nor very close out of the money options the trader has taken a balanced call. Now, three things can happen:

a) Nifty does not move: Its OK. If the trader took a credit while initiating this trade, he can keep the credit as profits. Or if he paid a small amount the loss is negligible.

b) Nifty goes up: Since the sold calls are still some distance away, chances are that Nifty will take some time to reach the short strike. Now Theta will do its job and take premium away from the sold options. Of course the bought options that are in the money having higher intrinsic value may still be making money. On top of that the decreasing volatility will also eat some premium from the sold options. The trader can exit as soon as Nifty reaches the sold options in profit.

c) Nifty falls: In that case the trader can keep the small credit that he got while initiating this trade. If there was a small debit, that is also fine.

I did not go very far to help you understand the strategy. When you trade take your own call.

This trade has maximum profits when the stock is exactly at the sold option strike on the expiry day. Of course if this happens before expiry, then the trade may be in loss or profit depending on volatility. If volatility dropped significantly, the trade may be in profit. If it increased then the trade may be in loss. It is advisable to take a stop loss when the stock reaches the shorted call option strike as potentially the losses are unlimited if the stock keeps traveling north.

Passage of time and decreasing volatility helps this trade.

Important note: Just to get a large credit please do not sell more options than what is described in this trade. You should only sell double or less number of lots of options than the lots of options bought. If you succeeded trading this once you may get overconfident and sell more options – this is where you may get in trouble.

Lets calculate the profit and loss of the above trade on the expiry day:

1) Nifty at 8700 exactly at the bought option strike:

All options expire worthless. The trader can keep Rs. 16,000.00 or whatever the credit he got while initiating this trade. Note that anything below the results will be same.

Lets calculate return on investment (ROI):

Rs. 13,500 is blocked to sell one lot or 25 shares of Nifty. We sold 200 shares. So total lots sold = 200/25 = 8 * 13500 = Rs. 1,08,000 blocked as margin.

Rs 26,600.00 was blocked for buying 100 shares of 8700 strike call option.

Total money blocked: 1,08,000 + 26,600 = Rs. 1,34,600.00

ROI: (16000 / 134600) * 100 = 11.88%

This is a very good return in 30 days.

2) Nifty at 8800 exactly at the sold option strike (this is the maximum profit zone – please refer image above):

The sold options expire worthless.

Credit from the sold options: Rs. 42,600.00

Calculating loss from the bought options:

The 8700 call option will be 100. So the loss = 100-266 = -166*100 = -16,600.00

Total profit: 42600 – 16600 = Rs. 26,000.00

ROI: (26000 / 134600) * 100 = 19.31%

This is amazing return in 30 days.

3) Nifty at 8900 (profits will start reducing):

8700 Call is 200: 200-266 = -66*100 = -6600
8800 Call is 100: 213-100 = 113*200 = 22600

Total profit: 22600-6600 = Rs. 16,000.00

ROI: (16000 / 134600) * 100 = 11.88%

This is a very good return in 30 days.

4) Nifty at 9000:

8700 Call is 300: 300-266 = 34*100 = 3400
8800 Call is 200: 213-200 = 13*200 = 2600

Total profit: 3400+2600 = Rs. 6,000.00

ROI: (6000 / 134600) * 100 = 4.45%

This is a good return in 30 days.

5) Nifty at 9100 (break even breached – losses begins – here is where you should take a stop loss):

8700 Call is 400: 400-266 = 134*100 = 13400
8800 Call is 300: 213-300 = -87*200 = -17400

Total Loss: 13400-17400 = Rs. -4,000.00

ROI: (-4000 / 134600) * 100 = -2.97%

Negative ROI.

6) Nifty at 9200 (losses escalates):

8700 Call is 500: 500-266 = 234*100 = 23400
8800 Call is 400: 213-400 = -187*200 = -37400

Total Loss: 23400-37400 = Rs. -14,000.00

ROI: (-14000 / 134600) * 100 = -10.40%

Negative ROI.

For every 100 points move up the trader will lose Rs. 10,000.00

And virtually since Nifty can move up to infinity – the loss on paper is unlimited. However we all know that somewhere the trader will take stop loss.

Important: This is looking like a great trade as losses only begins after Nifty travels a considerable distance. But you do not know how fast it may happen. If it happens very fast you may lose a lot of money even if you take a stop loss a couple of 100 points away. And since a major event is coming this Saturday (stock markets will remain open like normal trading day), its not the right time to play this trade. If you want to, please let the Budget pass away.

Also once the Budget is over, the premiums of the options will come down drastically because the volatility will crash. Due to this your break even will also get reduced and therefore short ratio call spread will become slightly more risky. If you chose your strike prices correctly and you are ready to take a stop loss, you can trade this strategy.

Conclusion:

• Short Ratio Call Spread is done by buying one in the money call option and selling double number of out of the money call option.


• Risk is unlimited, Reward is limited.


• It works best in a range-bound market and volatility dropping.


• You should take a stop loss when the break even is breached. You should have done your calculations before putting the trade.


• Do not trade when a major event is near.

Let me know issues faced in short ratio call spread if you ever traded.

Well yesterday I got an email which was very disturbing. Someone lost more than Rs. 2 crores trading options.

Click on the image below to enlarge and read the email properly.

Rs 2 Crore Loss – Click to Enlarge

Disclaimer: I cannot verify the authenticity of this email nor do I know whether it is true or not, but if it is, then probably this is something un-explainable and inexcusable.

I mean you cannot lose so much money that can change your life. 5-7 lakhs is ok. In the long run it won’t matter much, it will not change your life. But that is it.

Here is another trader who lost more than Rs. 40 lakhs.

If you have lost more than a lakh in the stock market, you should stop trading and learn trading – not just keep speculating and losing. Most of the traders who lose money are option buyers.

Read this article to know why option buyers never make money over a period of time. By the way selling naked options is even more dangerous.

Just imagine what this person could have done with this money or anyone of us can do with so much money especially in India. I mean you need not work for the rest of your life and still generate enough money every month from guaranteed returns that you would find hard to finish even if you live a lavish lifestyle.

If he bought a big house in any city of his choice, and a great car for 1 crore (85-90 lakhs for the house and 10-15 lakhs for the car. I know car lovers will hate me for this but in economics the car has a diminishing return – the house can be sold at a profit 🙂 ) – he would still be left with Rs. 1 crore. If he goes and fix this in a bank – he makes Rs. 72,588.00 per month from interests alone (calculated at current Bank Fixed Deposit (FD) of 8.75% per year).

Better still if he keeps this in a debt/liquid fund which returns better than Bank FDs, then he makes even more. Currently debt funds in India are making more than 10% a year – but it keeps changing and is not guaranteed “on paper”. However they return better than bank fixed deposits.

Whats more, if he can somehow keep that money in the debt fund for three years – then the tax on the returns gets highly reduced. You only pay 20% of the profits after indexation. Bank FDs returns are taxed as per your income slab even if it is kept for 5 years.

He can always invest 50% in bank fixed deposits and 50% in liquid funds to diversify the risk. Click here to read how I manage my financial portfolio and diversify my risk.

He can spend the money earned from interests guilt free, as he likes, without saving one rupee from it as he will again get 72,588.00 (or more if 50% of it is in liquid fund) next month. 🙂 Even after spending this much money, he gets to keep Rs. 1 crore. What a loss.

Here are some more loss stories that I was told on phone or email. All personal details of the trader is kept confidential:

I know one person who did not take a stop loss even when his losses were at almost one crore. He had sold too many naked Nifty Futures when Nifty was rising in 2013-14 thinking it will come down. This was when Nifty was at 7700. I asked him to take a stop loss immediately but he did not. Today Nifty is nearing 9000, if he has not taken a stop loss imagine where his losses are today. This in a small city in Warangal – Andhra Pradesh.

At least five traders have told me their losses have exceeded 40 lakhs. One person sold his property worth lakhs and lost all his money trading intraday.

An engineer left a plum job of software engineer in Bangalore to do trading full time. Initially made a lot of money, got greedy and lost it all. Now he is asking his friends to look a job for him.

Here is another sad story from Goa:

Dear Sir,

My name is XXX, I’m from Goa, I have been a trader for almost 4-5 years with little breaks in between. But, I have never made any mentionable profits as such. Mostly it was like little profit, more loss, this cycle was repeated for quite some time, till my account eroded considerably.

Furthermore I had taken money from my friends and colleagues and lost it too (approx. 15 lakhs) now these people are behind me to pay back their money, making my life really miserable.

I used to trade mostly in Nifty Futures (Index Futures – most of the times I used to make profits) and Nifty Options (Index Options – always made losses, unless some fluke trade made me profit).

Now, my situation is so bad, that even my wife and parents are not so free to speak to me. They have become reluctant to even talk to me normal day to day talking, because they have come to know what I have done with my money and my friends money. My friends frequently call me on my phone and visit my home and threaten me. Now the situation has become unbearable.

Even my self confidence has gone so low, I hardly go out of the home, even if I have to go for some urgent work, I wear full face black helmet and go, to avoid the people from whom I had taken money. To make matters worse, I’m not even getting a job with justifiable salary in Goa (this is because of the break I took to do full time trading).

It has become difficult for me to meet my daily expenses, and I can’t support my family.

Sir, right now I have only 16 thousand rupees left in my trading account, and don’t have money to pay you fully for the course, but I can pay you Rs. 2,000/- now and Rs. 2,000/- after some days, when I start making profits with the Rs. 16,000 that I have in my trading account and taking support of your options course.

So, I request your good self to kindly bear with me and allow me to do the course with 2,000 now and balance 2,000 later. But one thing is sure that I will definitely pay your money, since you are my Guru.

Please help me Sir, I will be really grateful to you.

I asked him to look for a job and stop trading.

Another email:

I have been trading unsuccessfully since 10 years, meaning I keep changing strategies. I have a good understanding on trends, position sizing, supply and demand, however, when it comes to put on the trade, I am not consistent. The reason being I think directional trading can change your view with market ongoing. I also studied in depth options and have a good understanding on payoff, risk:reward, etc on option trading for iron condors, butterfly, credit spreads, etc.

What was difficult is that risk : reward are really risky when we see the actual options on NSE. i.e. you get less credit versus the risk. Sometimes it is skewed to 1:5 R:R. So if I think to earn Rs. 10,000 profit, I need to put on risk of Rs. 50,000. If the R:R is so extreme, I think 2 or 3 losses out of 10 will keep trading account in negative zone.

My view: 10 years of trading and still losing. Even worse he learned nothing. In 10 years a kid who was in class 1 will be appearing for his 10th board exams with a lot of knowledge about the world. What a waste of time. Money can be earned again, time will NEVER come back. To me time is more important than money.

This is what I replied: You may be right in what you say BUT only when you DO NOT manage risk well before time AND you have NOT hedged your positions.

Options can be made to play against one another.

Why let that 1 loss exceed the limit? Managing it before is the key and playing it smartly is also important.

There are countless stories I hear almost everyday but they are not worth mentioning. Please stop your trading if you are still losing money trading options. Read books or good websites online on options. I bet if you keep speculating, you keep losing.

Cheer up. There are some good stories as well. Someone told me that two guys in his city were making almost 5 lakhs every month trading options with a 40 lakh account. That is over 12% return a month. 🙂 Well congratulations if this is true.

So making money is possible but if you have some knowledge and have a strict plan. Enhance your knowledge in options and then trade. Please do not speculate. You will only lose money, and it will slowly accumulate to lakhs. Do not let yourself bleed slowly – you will not realize the small losses, but by the time you realize you may be deep in losses.

How much money have you lost or made trading options? Please do write in comment. Your email will not be shown and you can always use your first name to hide your identity. Thanks.

Short Guts is exact opposite of Long Guts. While in the long guts, In The Money (ITM) options are bought, in the Short Guts In The Money (ITM) options are sold.

A lot of traders in India sell naked out of the money options. If you are one of them please read this article. I am sure it will learn some very important information on shorting options.

Construction of the Short Guts

Sell ITM Call Options.
Sell ITM (same number of) Put Options.
It should be done on the same Stock or Index and of the same expiry.

Options sold should be same distance from the current spot of Nifty or the stock. The further you go, the lesser you make because time value decreases, but the risk reduces. The closer you come, the more you make but the risk also increases.

Note that in short guts you do not profit from the intrinsic value, you only profit from the time value and volatility in the option.

Risk is Unlimited and Reward is Limited.

Short Guts Profit and Loss image:

See that the loss is unlimited on both sides.

When to Trade Short Guts?

If your view is that the stock is going to remain range-bound for the next few days because there is no major event happening in the near future and the Volatility is also expected to reduce.

For example you traded Long Guts and because of the huge movement you got out in profit. Now the news is now out and there is not much to happen in the next few days, you can then trade the Short Guts.

Remember that the Volatility will not get to normal in one or two trading sessions. It will take time to decrease. So ideally the Short Guts should be played when the news is out a couple of days back and markets have factored in the news and it looks like it will consolidate for the next few days. During this time the Volatility that has risen high due to the recent news, will also climb down slowly to settle at reasonable levels. This is perfect scenario to trade the Short Guts.

When the stock is range bound Short Guts profit, because both the decreasing Volatility and passing time eats the premium of the sold options. The trader can buy back the options at a lower cost and exit in profits.

Is Short Guts a Credit Spread?

In technical terms, yes, because the trader gets a credit when he initiates this trade and one option or both options make money.

Though I feel its not right to call this a credit spread. A real credit spread consists of a short position of higher delta and a long position of smaller delta. The long option saves the short from unlimited losses.

In the short guts the losses are unlimited, so please do not trade this thinking you are doing a credit spread. If you are not buying an option you are at risk of unlimited losses. Click here to read more about credit spreads.

Calculating Maximum Profit in Short Guts

Let me get real prices to help you understand how to calculate max profit:

Nifty on February 10, 2015 closed at 8565. Let us sell 8800 Feb PE and 8300 Feb CE. Note that both are almost 250 points away from spot and both are in the money options (and NOT out of the money like most traders love to sell).

8300 Feb CE: 347.00
8800 Feb PE: 227.00

Assuming someone sold the above options 1 lot each (or 25 shares of Nifty).

Max profit = Total credit minus difference between the two strikes minus brokerage (we will ignore brokerage)

= (347+227) – (8800-8300)
= 574-500
= 74 * 25 = Rs. 1850.00

Calculating Return in Investment (ROI): (1850/27000) * 100 = 6.85% in 16 days.

Yes this is an excellent return if Nifty remains between 8800 and 8300, but this ROI is against an infinite loss. So trade with caution.

Please understand that if you trade this, as soon as Nifty is anywhere near the sold strikes you will start losing sleep. Why? Because if Nifty keeps traveling in the same direction you will start losing money. However you still have sometime before you actually make a loss.

Calculating the break even:

8800 + 74 = 8874
8300 – 74 = 8226

Which means you only lose if Nifty is above 8874 or below 8226 on the expiry day, else you will take a profit anywhere between 0 to 74 points depending on where Nifty finishes.

Warning: Do Not fall into the trap that there is zero to little chance that Nifty will be above 8874 or below 8226 on expiry day. It may happen or may not happen. The point is you do not know. But one thing is for certain that you may lose a lot of money in some or the other short gut trade some day.

Therefore it is very important that you always hedge your positions just in case something goes wrong. Also hedging will give you a peace of mind, though it will eat into your profits. Nothing comes for free. 🙂

Note that in long guts the trader profits if any of the option i.e. the call or the put exceeds the break even. Here it has to remain between the break even points to profit.

Important Tip: There is no need to wait till expiry if you are trading the Short Gut. Once you are making reasonable profits you should exit. Get that unlimited loss off the table. Do not get greedy to take it all. It may prove to be dangerous.

How to Trade Short Guts as Volatility Play

Once a major news is out and Nifty or the stock had a big rally up or down, it is usual for the stock to consolidate for some time. At this time the Volatility is high, but it will try to go the mean in a few days time. This “few days time” has to be caught by you.

See this India VIX chart (source: moneycontrol)

As you can see there is a huge spike during the general elections. From the day results were out VIX went from a high of 39.3 on 12-May-2014 to 20.63 on 19-May-2014. So someone who sold a short gut around 12th May would be in good profits on 19th May. In such a short time Nifty also did not move much. It went from 6900 to 7300. This small movement cannot damage the short gut. The trader could have exited with a huge profit.

Conclusion:

• Short Guts is a trade where the trader has a range-bound view in a stock or index.
• It is played by selling In The Money Call and Put options. Both options should expire the same day. The number of options sold also should be same to make it a neutral trade. Also the distance from the spot price when sold also should be same.
• The trader benefits if there is not much movement and volatility also drops.
• Its better to take profits out once the volatility drops and not wait till expiry because you do not know where this stock will be on the expiry day.
• Just as long guts, the short guts also cannot be compounded as too much money is at unlimited risk. One bad trade can take away years of profits made in this trade.

I hope you have learned some new things on shorting options. I am sure you must have shorted options at least once. Please let me know what difficulties you faced.