Though I always promote non-directional strategies, sometimes we as traders want to explore strategies to benefit from a directional movement.

Lets say a news has come in and its a good news. We know for sure that Nifty may move up for sometime at least till people fully digest this news. Strap Options Strategy is good for these times.

Note: Why does a stock or Index gives a knee-jerk reaction when a big news comes in? Because some kind of emotional trading starts taking place. If a good news comes in, most professional traders (who get access to this news much before retail traders) act pretty fast to make a quick buck or two.

Some days don’t we see Nifty jumping up 20-50 points in matter of minutes? Well that was news-based trading. Some big news comes in and a few stocks with lots of weight-age in Nifty shoot up, driving the Index too with them. By the time we, the retail traders realize, its too late. Some of us get caught in a trap (buying high) and ultimately lose money.

So how do we participate in this rally with least amount of risk and still make some money? You can try the Strap Options Strategy.

Lets discuss this strategy:

This strategy is to be traded when your view is bullish on Nifty or any stock. That is when you think Nifty/Stock will move up.

Construction of Strap:

1. Buy 2 ATM Call Options
2. Buy 1 ATM Put Option

Risk: Limited
Reward: Unlimited

Image of the Strap Option Strategy:

As you can see the call side will move up faster than the put side if the stock appreciates in value.

Can you recall something? Isn’t Strap similar to Long Straddle? A Long Straddle is a strategy where a trader has a totally neutral view. There too he buys both ATM Calls and ATM Puts BUT in equal number of lots, whereas in a Strap he buys double the number of ATM calls than puts.

So why should you trade a Strap instead of a Long Straddle when you have a bullish view?

Because if you are right you can make more money from a Strap than a Long Straddle. Calls will multiply 2 folds in profits whereas the Puts will only lose in half that amount. And moreover since option buying involves limited risk, the puts will lose only a limited amount of money and calls will bring in unlimited amount of money. 🙂 (Unlimited is only on paper – a trader must book profit somewhere.)

You must be surprised to know that Strap is not as popular a strategy than Long Straddle and Long Straddle itself is not as popular as direct buying of options. Do you know why? Because when we have a bullish view we all think we are smart enough and can make money and we really don’t need any protection. This is the sole reason why most retail traders lose money. Some lose in lakhs.

Long Straddle is played by many retail trades too. Here the logic is – wherever Nifty goes I will make money – down or up. Aha – only if money making was so easy. Everybody would have done a Long Straddle at the start of every series and made loads of money. Unfortunately we all know its not going to work.

In a Strap there is fear. And the fear is – what if Nifty goes down? Therefore he buys one put for two calls. If Nifty actually falls – the trader will make less profits from put than his loses from calls, but he will lose money, though less. Only exception is that if Nifty moves down pretty fast – than even 1 lot profit from the put will surpass limited losses from the calls. However it seldom happens.

So when and how should you play Strap?

1. When you view is strong and bullish on Nifty or any stock.

2. When the volatility is low.

Note: Usually when a news is expected volatility tends to increase. Because there is uncertainty in the markets. Unfortunately because of this you may have to pay more for the options. This is where it gets very tricky because as soon as the news comes in the volatility gets crushed and the options shrink in value. The trader then gets frustrated. He thinks even if his view was right – Nifty did go up – why is that he is still losing money?

The trader does not realize that volatility decreased and so his option values. That is why its very important that you buy these options at least 5-6 trading days before the news has to come in. It could be that you are in profit even before the news and you can sell them to make a decent profit.

Or, you can wait for the news to come in and let the volatility shrunk.

Unfortunately the problem with this is that Nifty would have already traveled its path – up or down and trader then feels a missed opportunity.

As you can see in both the situations above you have some pros and some cons but my experience says that it is always better to be prepared before the opportunity arrives. Once the opportunity goes it is very hard to make money in the stock market. Yes Nifty may continue the same path for some time, but the shrunken volatility ensures little or no movement in the options values. Which means neither the calls nor the puts will move significantly in premiums.

After a couple of trading sessions the trader seeing his calls and puts eroding in values sells them at a loss. Whereas had he bought them a few days back, he certainly would have been in profits.

3. When the options you are buying are actually ATM or very near ATM.

This is important because if the nearest ATM strike is where the calls are in the money then you pay more for the calls. This is not required. And if they are out of money, then the Put is in the money and you pay more for the put. This again is not required.

Ideally the premium of the calls and the puts should be the same so that you play a fair game. But if its near expiry and not much time is left for the news – you cannot wait for the stock to come to a nearest option in that case you can buy nearest ATM options.

4. When only 5-6 days are left for the current month expiry you should buy the next month’s expiry.

You may have to pay more for the options but at least you will have enough time to book your profits or losses. 5-6 days to expiry means you can lose 100% of your premium if there is no significant movement. This is what happens to most retail traders. They wait till expiry and every money they paid to buy these options goes away.

5. Do not put too much capital on risk.

Though this is a limited loss strategy, you can survive the game only if you are losing a limited amount in a trade. One big blow means you are out of the game forever.

Very Important Note: When playing a Strap do write down your profit and loss target. When anyone is hit you should close your trade. Do not trade on hope. When your profit is hit do not believe that more will come and be greedy. A profitable position today can be in loss tomorrow.

Similarly when in loss do not keep the position open thinking that Nifty will reverse or fall further giving you a profit. Nifty owes you nothing. That may happen or may not – a wise trader should take his profit or stop loss and wait for another opportunity.

Hope that will help you to play Strap the right way. And also give enough knowledge to know when to buy options and why you lose money buying options.

Have you ever traded Strap or the Long Straddle? If yes what was your experience?

This is the last article in the butterfly series.

Here are the rest:

1. Long Call Butterfly
2. Short Call Butterfly
3. Long Put Butterfly

… and this article is on Short Put Butterfly Strategy.

Note that the Long Call and Put Butterfly strategies work when Nifty expiry is very near the ATM strike that was sold. A credit is required to play the trade therefore the trade is called long butterfly.

Short Call and Put Butterfly works when Nifty is more than 100 points away in any direction from the ATM strike on the expiry day. The trader gets a credit therefore its called the short butterfly.

Unfortunately adjustments are costly and are not recommended. Since the risk and reward both are limited – basically a butterfly is a set and forget strategy. If it works – great, else you will have to take a limited loss. Mostly these strategies produce best results on the expiry day. And therefore should be traded 2-3 days before the expiry day.

Since some kind of prediction is required, I personally do not like or trade these strategies.

With the above in mind lets discuss the short put butterfly strategy.

When Should You Trade a Short Put Butterfly?

When your view is that the stock or the Index you want to trade will move at least 100 points away and hopefully will remain there during the expiry. Even if it does not move now, your view is that in due course of time Nifty will move away at least 100 points before expiry. This is a positional trade.

Have you ever noticed that when you want Nifty to move – it does not. And when you do not want it to move – it moves 100 points in no time. That’s stock markets for you. 🙂

Therefore butterfly strategy should be traded when you have a strong view of the spot where Nifty will be on expiry day. Tell me how many times will you be correct?

Its a neutral strategy, but high volatility helps because its a sellers trade and premium is the max profit.

Constructing The Short Put Butterfly Trade

1. Buy 2 Lots of At The Money Put Options
2. Sell 1 Lot of In The Money Put Option
3. Sell 1 Out of The Money Put Option

Risk: Limited
Reward: Limited

Let me get the real closing prices of the options that I will now show you as an example.

Date: October 28, 2014

Nifty Spot: 8,027.60 (markets closed for today)

Will treat 8000 as our ATM strike. Options prices are for options expiring on 30-Oct-2014.

Lets trade:

Buy 2 Lots of 8000 PE (ATM): 16.20 (16.20 * 50 * 2 = Rs. 1620/- Debit)
Sell 1 Lot of 8100 PE (ITM): 66.25 (66.25 * 50 = Rs. 3312.5/- Credit)
Sell 1 Lot of 7900 PE (OTM): 3.30 (3.30 * 50 = Rs. 165/- Credit)

Total Credit: 3312.5+165-1620 = Rs. 1857.50

Note: It does not make sense to sell a lot with a premium of 3.30. I know people do it on the expiry day. Frankly it is not a good strategy to sell options on the expiry day. The risk-reward is pathetic. Just imagine even if you are getting 5 points – that is getting Rs. 250 in one lot for unlimited risk. Is that justified? This is off-topic – but if you are selling options on the expiry day, you are doing a big mistake. Yes it is great to see options you sold expiring worthless and those last few moments are so exiting. But are you trading for fun or to make money? What if something goes wrong? You may have a huge loss. There are better trades. Please stop selling options on expiry day.

Ok. Coming back to the trade. Even though it does not make sense, technically to complete a short put butterfly, I had to do it.

You know what I will do in such a scenario? Being very practical, I will do the rest of the trade but not sell 7900 PE. There are still 2 days left for expiry. I don’t need that Rs. 165/-. That is the max I would gain and frankly it does not bother me. So I will take my chances.

What if next day Nifty suddenly moves down 50-60 odd points, or gaps down 100 points? May be that OTM option will then become 30 or even 50. I will then sell that option and complete the Short Put Butterfly trade. That way my returns will be more. This is called legging into a trade – but lets reserve this for another day.

If you have read the other butterfly trades I have written in my website, you would have realized by now that the butterfly trade is a set and forget trade. You should set it near expiry and close it at around 3.15 pm on the expiry day.

Assuming that we waited for the expiry day, lets calculate our max profit and loss.

Assuming Nifty closed exactly at 8100. (Today is the Oct 14 series expiry and Nifty closed at 8169 – so had I done this trade I would have made the max profit :))

Buy 2 Lots of 8000 PE (ATM): 16.20 – Expires worthless. (16.20 * 50 * 2 = -1620 Debit)
Sell 1 Lot of 8100 PE (ITM): 66.25 – Expires worthless. (66.25 * 50 = Rs. 3312.50 Credit)
Sell 1 Lot of 7900 PE (OTM): 3.30 – Expires worthless. (3.30 * 50 = 165 Credit)

Total Profit: 3312.5+165-1620 = Rs. 1857.50
Anywhere above 8100 closing the results would have been same.

Assuming Nifty closed at 8000:

Buy 2 Lots of 8000 PE (ATM): 16.20 – Expires worthless. (16.20 * 50 * 2 = -1620 Debit)
Sell 1 Lot of 8100 PE (ITM): 66.25 – is now 100. Loss 100-66.25 = 33.75 (-33.75 * 50 = -1687.50 Debit)
Sell 1 Lot of 7900 PE (OTM): 3.30 – Expires worthless. (3.30 * 50 = 165 Credit)

Total Loss: -1620-1687.5+165 = Rs. -3142.50

Assuming Nifty closed at 7900:

Buy 2 Lots of 8000 PE (ATM): 16.20 – is now 100 (100-16.20 = 83.8 * 50 * 2 = 8380 Credit)
Sell 1 Lot of 8100 PE (ITM): 66.25 – is now 200. Loss 200-66.25 = 133.75 (-133.75 * 50 = -6687.5 Debit)
Sell 1 Lot of 7900 PE (OTM): 3.30 – Expires worthless. (3.30 * 50 = 165 Credit)

Total Profit: 8380-6687.5+165 = Rs. 1857.50
Anywhere below 7900 closing the results would have been same.

Return on Investment (ROI):

Assuming Rs. 25000 is blocked for 1 lot Nifty option shorting. 2 options were shorted = Rs. 50,000.00 and Rs. 1620 for the option bought. Total margin blocked = Rs. 51620.

If profit: (1857.5/ 51620)*100 = 3.59%
If loss: (-3142.50/51620)*100 = -6.08%

This means you are risking 6.08% to make 3.59%. For some this is good risk-reward, for some it may be bad. For me it does not matter, since this involves predicting I would rather not trade the Short Put Butterfly Strategy.

This does not mean you should never try this strategy.

Best Time to Trade the Short Put Butterfly Strategy

1. Trade when the expiry is near. Why? Because this is a set and forget till expiry day trade. Your money will be blocked for a long time if you trade much before expiry and risk-reward will be almost same whenever you trade. Why would you block your money for so long? I would trade this just 3-4 days before expiry.

2. Trade when volatility is high. Why? Because you get high premium. Yes you also pay more for buying the ATM options – but if volatility is high you may also get more premium. Remember the total credit on the day you trade is your max profit.

3. If a big news is expected 1 or 2 days before expiry it helps. Why? Because the news will have some effect on the markets. For example yesterday night (India time) a big news came – Fed ended quantitative easing. (Quantitative easing is a funding system where Fed buys billions of dollars worth of bonds every month to pour a giant amount of money into the world economy. Some money of course used to find its way into Indian markets.)

This was a big news awaiting Indian and world markets. This news was coming just a night before the expiry day. Thus during such times the short put butterfly and the short long butterfly trades becomes excellent trades, because there is a high chance that Nifty will move someway or the other. For example today Nifty closed at record highs. It closed almost 1% up from yesterday’s closing. It closed at 8169.

4. If you are getting negligible premium by selling one leg of the trade, you can wait to sell it another time for a better premium. But the choice is yours. In the above case we would have lost that 165 Rupees.

Any Adjustments for the Short Put Butterfly Strategy?

No. Set and Forget. The results will come on expiry day. You know your max risk and max reward, why bother with adjustments. If you rollover your trade then only your broker will make money not you.

So Should You Not Take Any Stop-Loss As Well?

Well frankly this is very tricky to answer. If Nifty does not move, you will start getting bit nervous. If your max loss is something that you can digest, my suggestion is that its better to leave the trade for the expiry day. For example today itself Nifty moved 1%, almost all of that intraday.

Had a trader taken a stop-loss in the morning he would have felt bad. And interestingly that trader would have blamed his bad luck because Nifty moved after he took a stop loss. Was it really his bad luck? Or he did not have patience? Therefore trade with limited number of lots and max loss you are comfortable with, and leave till 15 minutes before expiry.

That ends the series on butterfly trades. Have you ever traded the butterfly. I am sure most of you do. If yes what did you trade? Did you make a profit or loss? Do let me know in the comments section.

Note: From tomorrow Nifty Lot size will reduce from 50 to 25 and the margin blocked will also drop by 50%, so please calculate the profit and loss accordingly.

I have already discussed how to trade Long Call Butterfly and Short Call Butterfly. This article discusses how to trade a long put butterfly.

Note: Most traders I have talked to like to play butterfly with call options and not with put options. I think it has more to do with human psychology than anything technical. We love to buy call options more than the put options, don’t we? I do not know the reason why, but I think we perceive markets going up more rather than down.

The fact is, it does not matter what option you are choosing to play a butterfly with, the risk reward will remain the same. Whether you trade a long put butterfly, or a long call butterfly – the risk and reward will be same.

When to Trade A Long Put Butterfly?

You should trade a long put butterfly when you have the view that the markets will consolidate for a few days. If Nifty does not move much and remains range-bound, you should be able to profit.

Risk: Is Limited
Reward: Is also Limited

Long Put Butterfly Trade:

1. Sell 2 ATM Put Options
2. Buy 1 Immediate ITM Put Option
3. Buy 1 Immediate OTM Put Option

Let me take a live example of market closing rates on Monday October 20, 2014.

India VIX is at: 14.19 (It is down 13.48% from previous close. But since you will be both a buyer and seller of nearby options – INDIA VIX does not have a big role to play in your trade. So while trading long put butterfly, your view is important – volatility cannot do anything to help or harm you. However if the volatility is high, it will help you to get good credit while selling ATM options, unfortunately you end up paying more for the other options bought. Vice versa when the volatility is low. As you can see volatility does not have a big role to play here. Though high volatility may bring in slightly more profits not significant.

Spot Nifty: 7879.40 (We will treat 7900 as ATM strike) Lets get the last trading prices of current month options expiring in 10 days from today:

1. Sell 2 7900 Put Options: 67.10
2. Buy 1 8000 Put Option (In The Money): 127.80
3. Buy 1 7800 Put Option (Out of The Money): 33.05

Calculations:

Sell 2 7900 Put Options: 67.10 * 50 * 2 = 6710 (Credit)
Buy 1 8000 Put Option: 127.80 * 50 = 6390 (Debit)
Buy 1 7800 Put Option: 33.05 * 50 = 1652.5 (Debit)

Total Investment: 6710 – 6390 – 1652.5 = Rs. (-)1332.50 (Debit)

Margin Blocked (as per NSE guidelines): 25,000 per option sold, 0 for OTM options bought, full money blocked for ITM option bought:

25000 + 25000 + 0 + 6390 = Rs. 56390.00 (Approx)

Now assuming that the trade finished perfect. One the expiry day Nifty is at 7900:

Sell 2 7900 Put Options: Expires worthless. The trader keeps the credit of Rs. 6710.00

Buy 1 8000 Put Option: is now at 100. Loss 100 – 127.80 = -27.8 * 50 = -1390

Buy 1 7800 Put Option: Expires worthless. The trader losses the money paid to buy this option: -1652.50

Total profit: 6710 -1390 -1652.50 = Rs. 3667.50

Return on Investment: (3667.50/56390) * 100 = 6.50% in just 10 days.

Isn’t this a great trade if it works well?

But I do not recommend trading butterfly. Lets see the reasons why?

Supposing the trade did not work well and Nifty is just 100 points up (at 8000) on the expiry day:

Sell 2 7900 Put Options: Expires worthless. The trader keeps the credit of Rs. 6710.00

Buy 1 8000 Put Option: Expires worthless. Loss 100% of the cash to buy it: -6390

Buy 1 7800 Put Option: Expires worthless. The trader losses the money paid to buy this option too: -1652.50

Loss: 6710 – 6390 – 1652.50 = Rs. -1332.50 (The initial cash invested to trade this strategy)

The results will be same if Nifty is anywhere above 8000.

Lets look at the lower end. Nifty is just 100 points below 7900 or 7800 on the expiry day:

Sell 2 7900 Put Options: The 7900 option is at 100. Original value: 67.10. Loss 67.10 – 100 = -32.9 * 50 * 2 = -3290.00

Buy 1 8000 Put Option: Is now at 200. Profit: 200 – 127.80 = 72.2 * 50 = 3610

Buy 1 7800 Put Option: Expires worthless. The trader losses the money paid to buy this option too: -1652.50

Loss: -3290 + 3610 – 1652.50 = Rs. -1332.5 (The initial cash invested to trade this strategy)

It does not matter where is Nifty below 7800, the trader will suffer the same limited loss.

Lets calculate the loss percentage.

NOTE: This is also very important from trading point of view. As a conservative trader, I want to know before trading what is my Max loss in the trade. If I am not comfortable losing that much money I do not trade or reduce the lot size.

(-1332.5 / 56390.00) * 100 = -2.36%.

Yes the risk-reward of -2.36% to 6.50% in just 10 days looks very attractive and traders get attracted to the Long Put Butterfly or the Long Call Butterfly, due to this. But unfortunately most butterfly trades are losers. WHY? Because a 100 point movement can come anytime – even in 1 hour. How can you avoid that?

The trade looks good when initiated, but as time passes and Nifty starts to move in any direction – you will start feeling the pinch. Traders are left hoping and praying Nifty does not move. With this trade what you are essentially hoping is that from the second you put the trade, Nifty should remain in a very tight range. How many times will that be possible? Possibly 1 in 10 times.

Is there any adjustment strategy to the Long Put Butterfly?

No. The only thing you can try doing is to move your trade where Nifty goes, you want your sold strike to remain ATM. Frankly, every time you do this, you will lose money. By the time the expiry day arrives, you may have lost so much money that even if Nifty expires at your new sold strike position – the profits will not be enough to cover the losses done while adjusting. The whole experience will also frustrate you. As you may have done a number of adjustments and even after Nifty finishing where you wanted, the trade was a loser. Your broker was a winner though. 😉

The only way out is to trade this when the expiry is very near – like today – expiry is just 10 days away. Or trade even just 5 days away as the risk and reward is limited. However after that your only job is to hope that Nifty finishes where you want it to be on the expiry day – adjustments if any will cost you. Close the trade at 3.15 pm on expiry day. If you made a profit, consider yourself lucky – the trade had nothing to do with your profits. 🙂 Do you really want to trade this now?

This is the major reason why I discourage any trade that requires any kind of prediction. If you want to predict – predict for the worst outcome – you will become a better trader. I encourage you to try non-directional trades where almost no prediction is required.

Today is Diwali 2014. Here is wishing you all a Very Happy Diwali and great trades in the future.

I hear a lot of stories on how people lose money trading options. Most of them are not worth sharing. But this one stands out and I thought I should share this with visitors of my website who are looking to buy that option for a big home-run.

Update: 40 lakhs looks too small compared to this aggressive trader who lost more than Rs. 2 crores trading options aggressively. You must read about this trader too.

I do not think anyone in this world exists who has had a real home-run buying options (I mean made so much money buying options that they can now stop trading and live a comfortable life). Yes, you will find people who are doing well trading options – but they have a solid strategy that they master.

Note: I have also written earlier why buying options will not make money over a long time. This post gives you a real example how things can go horribly wrong.

Recently I received an email from one one person from a small town in West Bengal, India. I have got his permission to share his email with this website visitors. If you are also looking for that home-run buying options you should read it:

Hello Mr. Dilip,

I stumbled upon your website from Google after searching for a low-risk options trading strategy for Nifty. And today, the whole day I was reading almost all stuff at your site. I can remember, while reading at your Yes Bank and IDBI trade, I myself and my uncle made an options purchase from a veteran trader’s call in a stock trading forum, that gradually worth around 6 lakhs went to zero, and we ended up loosing everything.

That was start few years back and by now I have donated most of the money to the market what I have earned from my now dysfunctional business – around 40 lakhs or more. Tried everything, Commodity, Futures, Pair-Trading. Less tried are Currency derivatives and Equity.

Now I can’t take any unknown risk. And at this moment, I am at a very crucial point of my life. I am 41 years old, have wife and two little kids. I have no job except some 15 lakhs FD that earns some interest, and around a 5 lakh trading A/c.

Right at this moment, I can’t have the luxury of loosing money any more. I know, whatever I have given to the market is just my mistake, I accept all the responsibility, because always I have placed large bets even after reading Van Tharp position sizing book. How silly I am – I always wanted to have that big home-run.

And I burnt my hand always.

Now I think it is the time to get all those money back with a constant rate. I do not want very high return, but a 5-6% per month steady return as per your strategy in any market condition and peace of mind will just do. Because, right at this moment, I am just looking to take care of my family, at least 30K per month is enough for me at this time.

Can you please help me?

Regards,
Name withheld

Isn’t this sad to read? Not only he lost lots of money, but he also lost a lot of time. Money can come back, time will never. A person who was once making 2 Lakhs per month is now dying to make 30 thousand per month. I know its painful, but greed took all money from this investor.

I asked him to first look for a job as a high priority. He has two kids and he is responsible for their well being and giving them good education. My course can of course come later.

I also told him if it was possible then he should again start that old business. He must be good at it that is why he was making so much money. That business was making him more than 2 lakhs per month, I see no reason why it cannot make 25% of that now.

Even a job paying 15-20k per month should be fine for him now. It will help him to meet the monthly expenses of his family. This will also ensure that he need not touch his bank fixed deposits.

If you are reading this and are in a similar situation, please take up a job as soon as possible. Then learn trading and start trading in small quantity. Once you are confident, only then increase your trading size. Do not fall for greed.

When I asked him why he did not stop at around 10 lakhs loss which is still bearable, he gave me a good reply.

Dilip, if you study Quantum physics, you will find that everything is vibration. When I earned that money month after month, it was my disbelief or low vibration about money in my Subconscious Mind that self-sabotaged me and took away all the money. At that stage, when I was earning even more than 2 lakhs per month in some months, my Subconscious Mind definitely rejected that idea or vibe – thought it was artificial or inflated and found a way to destroy that wealth and led me to join Stock market.

During six-month study period of your course, I must raise my vibration to a much higher level and must match those frequency at which that amount of money will manifest; otherwise nothing is going to happen for sure.

You may not believe, but it is true, if you wish, you can read a book called “Psycho-Cybernetics” by Maxwell Maltz.

http://en.wikipedia.org/wiki/Psycho-Cybernetics

OK may be this is true, but I still feel one should put a stop to ones greed.

Lets assume that he actually made 80 lakhs by buying options using the 40 lakhs money he had in his trading account. Do you think he would have stopped there? NO. His next target would be 160 lakhs and so on. Do you think he would have been successful every time he traded? Eventually he would have bought some option that would have expired worthless. He would still say the same story. It does not matter if he made 80 lakhs from 40 lakhs then lost it all – what matters is that he lost and he lost due to greed.

So, what are the lessons we can learn from this story?

1. Greed is bad in trading. Stick to your profit target or loss. Do not hesitate to take a stop loss if trade is not going in your favor. Also when the required profit target is met, do not hesitate to book profits. Waiting for more profits may take the trade back to losses. Similarly waiting for the trade to turn in your favor is futile – you will incur more losses.

2. Do not force yourself to trade. Just because you think an option will double in few days time does not mean you are correct. If you are not comfortable, just do not trade. Ask yourself before placing any trade – are you taking a big gamble? If the answer is yes – you are getting greedy and you should not trade.

3. If you want to speculate – then speculate for the worst possible outcome from a trade. Keep a plan ready when it actually happens. Stop loss or adjustments – keep it in writing.

4. Discipline is important. If you have only 10 lakhs to trade and have decided not to bring in any more money to your trading account, then do not bring any new money into it. That money may turn to one crore or zero. At least you will have the rest of the money to live your life and support your family. Read this to know how to manage your financial portfolio.

5. Money made from the stock markets is not free money. It comes with education, stress, strategy, planning and discipline. Do not disrespect this money. Psycho-Cybernetics or whatever is only an excuse – your money will not come back neither the time. If you are reaching your goals, slowly start withdrawing the profits from the trading account and put it in a liquid fund or bank FDs. Life has a limit – what makes you think that you will be trading forever and making money?

6. Share your profits and losses with your spouse. They have a different psychology and mindset than yours. I am sure he did not share his losses with his wife. Had he done that she would have asked hom to stop and concentrate in his business rather than the stock markets.

7. Always hedge your positions. That way even if you lose in one trade, the other trade will bring in some profits. If you are playing naked options, and if there is a huge gap up/down and your position is not hedged, you may lose massive money. You may never even get to take the stop loss because you will have lost it all.

8. Get some trading education. If you feel you are comfortable buying stocks – learn which stocks to buy and when. If you love future trading – know how to hedge them in the best possible way. If you love options trading – learn how they work, what are the best strategies that work.

9. Give the biggest priority to the source that generates the most income. If its your job – take it seriously. Work hard. Try to increase your salary. If its some business then read more about it. Master the craft. Become the best businessman in that field. If its stock market trading then do not stop learning even if you are the best in the world. Target small profits every month and be satisfied with them. Small profits will add up a huge amount in few years. Do not try for a home-run. It will slowly bleed you to financial bankruptcy and believe me you will never know. You will only realize when you will have already lost a substantial amount.

10. Greed and Fear both are your biggest enemies in trading. I am sure many of you are good traders but just do not trade because of the fear of losing. Interestingly even those who fear lose money. If you are good in trading but fear increasing your lot size then over a period of time you will end up losing even more than what greedy traders lose. Unfortunately you will never know. Don’t we hear stories from our friends/relatives who say, “Alas, if I had invested in so and so stock at that time I would have been a crorepati by now”. Well that was fear. Can you see one lost investment here is equal to one crore?

With this article if I am able to help you understand that Greed is not good neither is fear then I feel I have done my job. Learn to balance them and I bet you will become a good trader.

All the Best!

Most traders, not just in India but the whole world wonder if they can make enough money from trading to live a comfortable life. Yes the real question is if they can leave their day jobs and make similar amount trading the stock markets to feed their families.

Well frankly I really don’t get this. Why everyone want to leave their jobs? Lets keep it for another day.

I get many phone calls and mails asking something similar on the above lines. However recently I got this email from one of my subscribers Mr. Chandirasekaran which is quite interesting and I would like to share his question too. I have taken his permission. My answer follows the question.

Hi Dilip Shaw,

Fantastic article on how to manage our finances!

I also agree with your views on Gold and property. Gold is not very lucrative over longer periods compared to equity. Similarly property is illiquid and not suited to middle class people like us as you rightly mentioned.

By the way I wanted to ask you something. Its inspiring to know that despite 7 lakhs loss, you have learnt some hard lessons and finally came out of it and now able to generate sustainable income.

Now I just wanted to know whether you are able to make money on an annual basis at least 70% of your last salary from options/equities etc. consistently? I mean whether you are able to meet all of your family monthly expenses and also able to lead a comfortable life?

Thanks & Best Regards,
Chandirasekaran

This was my response:

Hi Chandirasekaran,

Thank You for the kind words. 🙂

If you read my article here:

http://www.theoptioncourse.com/strategies-can-help-grow-money-power-compounding/

You will find this:

Most traders who take my options trading course ask me what I do with the profits earned with my trades. Well I believe in power of compounding. Frankly right now I do not need the money that I make from trading or the stock markets. So I would rather make sure I am compounding it. If I take it out and do not use it, and assuming I keep it in my bank account – it will grow at only 3.5% per year. Compare this to almost 3% per month. So where should I keep my profits? Of course I should reinvest it. If I keep re-investing in my trading account it will grow much faster than if I put it in my bank account or even an FD.

You got your answer. I strictly follow the 25-25-25-25 rule. (25% of my savings goes into Government backed securities like FD, PPF etc, 25% goes into 4/5 star rated mutual funds, 25% goes into direct equity buying of companies with strong management and the rest 25% comes into my trading account. However since my limit of investing in the trading account is reached I do not add any more money into it – but do not withdraw the profits as well – so indirectly I am investing into it. For more detailed info read here.) Even if I want my wife will not allow me to invest more in my trading account. She cannot forget the bad times, and even today the pain is in me. In 2011 I really had a tough time to convince her to put some money out of our savings again into my trading account. It came out to be a good decision.

However it does not mean I am not investing more into it. The profits generated are also earned money right? So investing 100% of the profits back into my trading account is also the same as bringing new money into the trading account. Essentially I do not feel the necessity to add any extra money to my trading account. Another reason is my limit of bringing new money into my trading account has been reached, so that law does not allow me to bring any more money. Yes temptation is there but I will not fall for it. However by not withdrawing money I am increasing my trading kitty. Hope its clear, bringing more money into the trading account every month or investing the profits back into it is the same.

To answer your question – my account is still not that big that I can withdraw money from it every month and live a comfortable life. But if I keep going at this rate – eventually in 4-5 years I will be able to leave my part-time consulting job. But frankly I love my job, so I am not sure if I will leave it soon.

I understand why you asked this. Most people who call me ask the same question. Can they make enough from trading to live a comfortable life?

Well it depends on your needs, the kind of profits you can generate from trading and cash in your trading account.

For example Family A may need Rs. 50,000 per month to live comfortably. The head of the family is smart and makes 10% profit per month, but his trading account has only Rs. 1 Lakh. He cannot leave his job at least now.

Family B may need 1 lakh per month. They generate 5% profits per month and their trading account is 20 Lakhs. Yes target met. Their bread earner can leave his/her job.

You get the point. Your family needs, the profit percentage and cash in trading account – all will have to be taken into account when someone decides to leave his job and fully depend on profits generated from trading.

Frankly you will find few people doing that. Even hedge fund managers have a job. Mutual fund managers have a job. You need a lot of money to make a lot of money. But one can get there, it only needs determination, hard-work, patience and a step by step approach. It will take time.

Since Mr. Chandirasekaran asked me this question, I will try to explain it as a normal retail trader. But please assume that it could be you.

In a worst case scenario at 2-3% a month a 10 lakh account may be making anywhere between 20,000 to 30,000 a month. For me that is not enough. I need to make at least one lakh a month to live comfortably. For that around 40 Lakhs is needed. When you have 40 Lakhs to trade it has to do with traders mindset as well.

1. If I have only 40 Lakhs as savings – it is foolish and suicidal to keep 100% of it in a trading account. One silly mistake can take it all. What if by mistake you press the “sold” button and thought that you have actually “bought” and did not see the order/trade reports or the Contract Notes. Yes it is a rare blunder – but what if this happens? We are humans and we can do mistakes right? After a few days you check to see that option has doubled and eventually when you wanted to book profits you find that you have lost a lot of money because you did a silly mistake. Remember you will not get back this money.

(On the day I trade in the evening I check my email to see the Contract Notes. This essentially makes sure I double check my trades – one in my trades report and second in my Contract Notes. All traders should do this as well. This will ensure a 100% accuracy in trades. If you have done a mistake you can rectify the very next day.)

2. Even if you have more money stacked somewhere you will get stuck with two choices:

a) If you keep 40 lakhs in a good debt fund or FD it will give you a return of around Rs. 30,000 per month without any work or stress on your part. Compare this to all the hard work and stress required for trading.

b) If you have 40 lakhs more in FDs or whatever you tend to be complacent. You try to get aggressive. Why? Because you have a lot of money (around 80 lakhs) – now you want to make even more “lots of money”. Greed leads a trader take huge risks and lose a lot of money. One trader a few days back called me to say its ok for him to lose Rs. 30,000/- per month but not more. WHAT? He is willing to lose that much per month. Why? Because he generates 1 lakh in interest per month. Frankly I think he does not need any more money – he wants to trade to pass his time or try aggressive trading to make loads of money. Probably just to satisfy his ego. People trading to pass time/kill boredom/have fun and/or aggressively trading to make a killing – all are doing a big mistake. They will most certainly lose money.

One trader with more than 1 crore in his account took my course. I asked him why is he taking my course? He already has a lot of money, so what is the need to trade with so much money? (Well there is nothing wrong to trade with a one crore account, but I just wanted to ask. How many times do you get an opportunity to talk to a retail trader with a one crore account? As a trader I wanted to know his psychology.) He said that he loves to double his money.

Well here is the story: He started with a few lakhs, took the account to one crore and on that day was sitting on a unrealized loss of 90 lakhs. Like I said these people take unlimited risks, because they have unlimited money and they do not care.

It comes back to the same question – can you generate enough to make a living out of trading?

Yes it is possible, but you will have to do a serious introspection on why you want to do this. Firstly ask yourself why you want to leave a lucrative job? If you love your job – what is the need to leave it? Is your job hard work? Well trading is also hard work. It is not a cake walk else everyone would have been successful. But if you really hate your job and are serious enough to trade and make a living out of it here are the steps you need to take in order to reach there:

Step 1) Invest money in stock trading education. There are books, websites and people offering education. Get education from reliable sources. Learn some trading strategies.

Step 2) Start paper trading on the strategies you are comfortable with. When you are paper trading be serious. Treat this as real business and real money even if no money is involved. When paper trading I recommend trading with at least 10 lots or more. Remember no money is involved so you should learn as much as possible. With 10 lots you will make or lose a lot of money – this will help you to understand what happens when you will trade with a lot of money.

Write the trades in a notepad or excel sheet. You should also approximately deduct the brokerages even if this is paper trading. This will help you to calculate real ROI. Paper trade for 3 months at least. If you are making losses. Go back to Step 1. It means your knowledge is lacking or your strategies needs improvement. Come back to Step 2. Again practice for 3 months. If profitable even 1 percent, go to step 3.

Step 3) You are now confident and ready to trade. Take some money out of your savings (at least one lakh) and put it in a trading account. Make sure your trading account is with a discount broker charging Rs. 20/- or less per trade not per lot. This will save you a lot of money on brokerage.

Step 4) Its time for real trade. Trade small in one or two lots only, even if you feel great and want to go all out. If you are successful for 3 months, increase the trades with 1 lot.

After one year consider yourself successful trader if you have done at least 50 trades and made even 1 rupee profit. Yes its good enough to break even in your first year of trading.

Now if you feel money is short, this is the time to add money to your trading account. You are making profits – there is nothing wrong in adding money to a small account. Add small and a fixed amount every month. However you should keep an overall limit. Like this it will take some time but eventually you will reach a point where you will be comfortable trading and making enough to support your family.

Step 5) Leave your job when you are 100% sure you can make a living out of trading.

Step 6) Do not get aggressive and take huge risks when your account has grown big. You may not believe but this is the most difficult step to follow. As I have said people with huge accounts rarely make money because losing a few thousands every month mean nothing to them as they want a big killing trade. For this one trade they keep taking big risks and keep failing until they realize their account is fully blown up. At this time it is too late to recover.

There was one option trading firm in USA that lost years of profits in just one bad trade. I hope if you are already there or will reach there one day, will remember this article and not commit such a blunder.

In the whole process keep your spouse in the loop. Profits and losses should be shared. Why? This will stop you from taking unnecessary risks. In the back of your mind if you know that you are answerable to someone, you will never take big risks. Sharing your profitable trades will make you happier and sharing your loses will reduce the pain. It looks trivial but it works.

As you can see growing slowly is the mantra. Compound your money to such an extend that you feel comfortable leaving your job. If you take it step by step – that day will come sooner or later. But if you want to jump and reach there fast – you will fall and fall badly.

I hope you got the answer.

All the best to all those who want to accomplish this, and of course to other traders as well.

Many Thanks.

One of the best things about this website is that I come to know some amazing and some not so amazing traders in India.

Well unfortunately most traders are losing money. 🙁 Why people lose money is that they do not have a trading plan to execute when their prediction goes wrong. They simply do not know where to take a stop loss or to book a profit. I mean when you trade you should have a trade plan in place. You should know clearly when to take a stop loss and when to take out profits.

If you take a stop loss at 50% of your profits – even if you are right 50% of the times – you will make money. Risk management is the most important decision in trading which everyone forgets.

Some get too aggressive and lose money. (Aggressive traders lose the most). Some book profits at an early stage when more profits may have come. Some just start praying to Gods for help when losing money. I mean what can Gods do if you never had a trading plan or you over-traded? Some hope that one day before expiry Nifty will reverse trend and they will be able to book profits. And you know what – it gets worse on the expiry day.

Trying to make money on hope and praying to Gods when in trouble is a different chapter of trading altogether. Out of scope as far as this article is considered. 🙂 (BTW I have been there done that 😉 )

If these are your trade plans, how on earth you are going to make money?

When I lost 7 lakhs trading I thought I am one of the worst trader in the world. The day my losses touched 7 Lakhs I slapped myself – yes literally slapped. How can greed overcome me? How can I lose so much? I was young – I could have just kept the money in a FD and it would have grown at least 50% in 4 years. But once money goes it goes – it never comes back. You will have to work hard to make more money. This hard work has nothing to do with the lost money. That one pain is going to stay for long.

Today I consider 7 Lakhs as tuition fee to the stock markets. Today I know that 7 lakhs I lost was nothing compared to what some big traders lose. At least I stopped there, learned a lot from my mistakes and started learning options trading.

But traders out there just do not want to learn. If they earn a rupee they think they are smart and can earn more. And when they lose double that they blame on luck. This continues until losses runs into lakhs.

Read this and you will be in shock too. Some of the traders are running in losses amounting to tens of lakhs. One of them living in a small town in Andhra Pradesh is currently sitting at MTM (mark-to-margin) loss of Rs. 90,000,000.00 (90 Lakhs). Are you nuts? I mean most people on Earth cannot even earn that money in a decade and here is one guy who is just destroying his wealth. All this in span of two months. When I asked him why he did not take a stop-loss he said he hates taking stop loss. What an answer. Trading is a business and when in loss – you should take a stop loss or hedge your positions.

There is more. He told me there are many more people in that town who have lost more than that amount. If a small town in AP can have retail traders trading with more than 1 crore capital, then imagine how many traders are there in India trading with that much capital?

Another software engineer was sitting at a real loss of 45 Lakhs. He buys options. Well if you also do the same take this as a warning.

If its true that 95% of retail traders are losing money – imagine how much money is being sucked from the retail traders by the FIIs, DIIs, and smart retail traders.

I have found that losses do not accumulate in a day. If you put a frog in hot water, it will jump to save his life. But if you put it in cold water and boil it slowly – the frog will not come out and boil itself to death.

Which means losses keeps on accumulating and the trader brings in more money and keeps loosing. Only to realize one day that his looses are running into lakhs. By this time it is too late to recover.

All these things happen because we never have a risk management plan in place. Well most do not even have a financial plan in place. Risk management is a small portion of your financial plan. Below I will try to address both.

How do you make sure that Risk is properly managed and you do not lose more than you can afford while trading?

Here are some steps that you need to take immediately if you want a sound financial future:

1. Do not bring more than 25% of your savings into your trading account. First of all why do you want to bring too much money into your trading account? To make more money? Well if you cannot be profitable in a small account how can you be profitable in a bigger account? In fact traders who are losing money should not bring any more money into their trading account. You will lose even more. First prove yourself that you can make more than 2% profits per month in a small account on an average for the last 10 months. Once you have crossed that threshold – you can bring more money every month. Keep a fixed amount to add to your trading account every month for a certain period. Because if you bring in a lot of money at once and take a stop loss in a big trade – you can lose a lot of money. But a fixed amount will ensure a small loss.

2. If you trade on a leverage you should always hedge your position. Future and Options both are traded on leverage because you only trade with 10-15% of the value of the trade. If you make money that is good, but if you lose you will lose on the value of the transaction not on the margin blocked. This is even more important if you are keeping the position overnight. Lets say you have Rs. 50,000 in your account and you bought 2 lots of Nifty future risking everything you have in your trading account and next day there is a gap down of 300 points.

I bet you will square off your position in panic. This is what you will lose then 300 * 50 * 2 = Rs. 30,000.00. This is 60% of your trading money. Do you think you will have enough courage to ever trade again?

But had you done some kind of hedging – like buying OTM puts I am sure you losses would have reduced to 20% of your money. This will leave you with some courage to trade again.

In stock markets always risk what you can afford. The money that you cannot afford to lose should be kept in fixed return instruments. Let the financial analysts say that Fixed instruments are boring and all that – the fact is they themselves are doing exactly opposite to what they are saying.

They have a job right? So they will say what looks good, but may not work as suggested. Which is better – losing money trading or putting money in an FD that generates 9% return every year for doing nothing?

Long back I had written an article on investment opportunities in India. It is highly recommended that you read that.

Here is how you should divide you savings. I believe in 25-25-25-25 rule.

(This is my belief – yours may differ – but I believe dividing money in different assets class. This will ensure less volatility in our financial portfolio.)

This is what I do (and you can do too):

25% of what you save should get into fixed return instruments guaranteed by Government of India. These are bank fixed deposits, post office schemes, EPF, PPF etc.

25% of what you save should get into diversified equity mutual funds. Select 3-4 different mutual funds based on their last 5 years performance. Invest only in 4 or 5 star rated funds by value research. These funds should be from different fund houses and their investing style should also be different. For example you can select one large cap fund, one mid cap fund, one small cap fund, and one thematic fund in a sector you believe in. Invest through SIP (Systematic Investment Plan to take advantage of averaging your cost of buying these funds). If possible invest in Direct plans to save money. Review every year to change any fund that is not performing.

I was surprised to know that most option traders do not invest in mutual funds. Why? They do not need your time and hard work. A very qualified fund manager works on your behalf. The fee they charge is also less – so why not make use of this great opportunity? Over a long period of time good mutual funds can generate 12-15% returns a year. Without any work I think it is a fantastic return.

25% of what you save should get into good large and mid-cap equities. Yes direct buying of stocks for long term. Here too buy systematically every week or month. Never buy any stock in bulk. If you have any stock that you want to sell, its better to start a covered call rather than direct selling. That way you will still make money if the stock does not reach your call strike price.

25% of what you save every month may come into your trading account. Since this is the most riskiest of all the above investments – you should have a limit to how much big your trading account should be. This will differ from person to person but you should know your limit here. Once that limit is reached – you know that it is the maximum you will lose if anything horrible happens. Once this limit is reached – do not bring any new money to your trading account. Just reinvest the profits and compound it. Compounding is magical and therefore you need not bring more money to it once the limit is reached.

One more thing – instead of putting surplus money in your bank you can put them in a liquid mutual fund. These funds generate 8-9% returns a year. This is much more than 3.5% Indian banks give as interest. Liquid funds have no entry or exit cost – so they are as good as any bank deposit. What’s more you can invest online and withdraw money to your bank account online.

Also if you are the head of the family and your family depends on you financially, you should always buy a term insurance policy. In case something happens to you – your family will get the sum assured and at least financially they will not be worried. Buying them online will be cheaper.

Of course now days everyone has a medical/health insurance. If you don’t have one – buy as soon as possible. Don’t forget to have a family floater plan that will cover all your family members. One major health issue to any family member can make a huge dent into your savings. Health insurance is a must.

As you can see I have not included real estate, gold and ULIPs in my investments. These are one of the most sought after investments in India. But I do not like them for the following reasons:

Real Estate: Will eat up a significant portion of your savings. If you have not timed your buy correctly or were not able to negotiate well, you will find it hard to find a buyer to sell in profits. Its a big investment – it carries a major portion of your savings so you will always be worried. (I hate worrying about money) Every month you will have to pay the mortgage, pay electricity bills, municipal taxes, clean the house etc. Repairs costs money too. Mortgage costs money. If you want to rent then finding a good family for renting is not an easy job. When they leave you will have to spend a lot on repairs, paintings etc.

People like us can invest in at most two houses. One where we live and another for investments. Investment in just one real estate is a hit or a miss thing. Either you make good money when you sell or you make average or even a loss. To make good profits you have to keep it for ten years at least. And if you make only 10% compounded annually minus your expenses, you made less than what a good mutual fund could have made without any work on your part. Not a smart choice in my view. If you want to invest in real estate just buy one property where you can live.

Here are more links about why real estate is a bad investment:

http://www.iwillteachyoutoberich.com/blog/surprising-real-estate-investing-myths/

http://www.cbsnews.com/news/history-says-home-real-estate-is-a-bad-investment/

http://www.myonemoney.com/inside-edge/money/278-why-owning-a-home-is-a-bad-investment–but-often-a-smart-decision

Gold: This is another investment I hate. Gold will never beat equity returns over a 10 year time frame. Still if you want to invest in Gold – you should invest in Gold ETF every month or do a SIP in a good Gold fund. Redeem them when your kids get married to buy gold and/or when you want to buy gold for any occasion.

ULIPs – Unit Linked Insurance Plans: Worst investment ever. Government of India should ban ULIPs. Even if markets give a return of 30% – ULIPs will only generate 10-15% or even a loss. Because its a costly investment. A major portion goes into buying insurance for the owner. Yes you may not get anything in return in a term insurance if you survive the term – but if something happens to you then ULIPs will not give your family the kind of money they need. It won’t solve any purpose. Moreover its market dependent. When it is redeemed and markets are down you may lose money. Keep your insurance and your investments separate and you should get better returns. ULIPs do not solve the purpose of either insurance or investments – so they should be avoided.

IMP: Every quarter you should count your worth. This will help you know your wealth and what you can expect from future. It will also tell you any mistakes you made in the past. This will help you to plan well. If you are strict with your finances, I assure you will only get richer with time.

Happy Investing and Wishing You the Best For Your Future!

Disclaimer: The views expressed in this article are of the author. Please do your own research before investing money in anything. This is the way I manage my finances and am comfortable. Your situation may be different. Therefore you may want to take a different approach. The only benefit of the above investment approach is that the finance portfolio is less volatile. However it is recommended that you do your own research before taking an investing decision. Do not take investment decision in a hurry.

If you have read my post on Long Call Butterfly, this trade will be easy for you to understand. Results for the Short Call Butterfly will be exactly opposite of the Long Call Butterfly.

Lets discuss the trade straight away.

When should you trade Short Call Butterfly?

You should trade this strategy when you think that Nifty will move away from the current strike and expire 100-200 points away on the either side – up or down does not matter.

Three trades are involved (note that these trades are exact opposite of the Long Call Butterfly):

1) Buy 2 lots ATM (at the money) Call Options
2) Sell 1 ITM (in the money) Call Option
3) Sell 1 OTM (out of the money) Call Option

Risk: Limited
Reward: Very Limited

Now lets take a real world example and what profit or loss the trader can make.

(Spot Nifty – 7905. Prices as of August 26, 2014 after markets closed. India VIX (Volatility) – 13.90 – Average. Taking September 2014 expiry as August expiry in 2 days. Option prices rounded off for clarity.)

1) 25-Sep-14 CE 7,900.00: 135.00

Buying 2 Lots = 135*50*2 = 13,500.00 (Debit from account)

2) 25-Sep-14 CE 7,800.00: 200.00

Selling 1 Lot = 200 * 50 * 1 = 10,000.00 (Credit into account)

3) 25-Sep-14 CE 8,000.00: 83.00

Selling 1 Lot = 83 * 50 * 1 = 4150.00 (Credit into account)

Total credit: 10,000 + 4150 – 13,500 = 650 (This is the maximum possible profit)

Total margin blocked: 62000 (approx)

ROI: (650/62000) * 100 = 1.04% in 30 days. In my view this is slightly better than a bank fixed deposit, and at par with many mutual funds. Any strategy that makes less than 2% in 30 days should not be traded. Trading is a business and returns should be attractive.

Return on investment is poor – in fact it is very poor. Such trades with low ROI and high risk are best avoided.

We will now see that risk-reward ratio in this trade is pathetic too – but success rate is good as there will be a movement in Nifty and near expiry if Nifty is away from the strike price of the bought calls – on either side, the trader can book his profits. But unfortunately one loss can take away months of profits. So lets try to find what happens if this trade is successful and what if not.

Lets take an example of when this trade is successful:

Nifty is exactly 200 points above bought call strike price of 7900: 7900 + 200 = 8100 on expiry day.

Calculations:

1) 7900 CE is 200: Profit: 200 – 135 = 65 * 50 * 2 = 6500
2) 7800 CE is 300: Loss: 200 – 300 = -100 * 50 * 1 = -5000
3) 8000 CE is 100: Loss: 100 – 83 = 17 * 50 = -850

Total profit: 6500-5000-850 = 650

Note that profit remains same if Nifty is above this anywhere.

Lets take an example of when this trade is successful on the down side:

Nifty is exactly 200 points below bought call strike price of 7900: 7900 – 200 = 7700 on expiry day.

1) 7900 CE is worthless: Loss: -13500
2) 7800 CE is also worthless: Profit: 10000
3) 8000 CE is also worthless: Profit: 4150

Total Profit: 10000 + 4150 – 13500 = 650

Note that if Nifty is anywhere below this on expiry day, the results will be same. The trader will make a small profit.

Now lets analyze the situations where the trader can make a loss.

Nifty is exactly on 7900 on expiry day – the strike price of the bought calls.

1) 7900 CE is worthless: Loss: -13500
2) 7800 CE is 100: Profit: 200 – 100 = 100 * 50 = 5000
3) 8000 CE is also worthless: Profit:: 4150

Total loss: 5000+4150-13500 = -4350

Nifty at 8000:

1) 7900 CE is 100: Loss: 135 – 100 = 35 * 50 * 2 = -3500
2) 7800 CE is 200: No Profit No Loss as it was 200 = 0
3) 8000 CE is worthless: Profit: 83 * 50 = 4150

Total Profit: 4150-3500 = 650

We have already calculated 8100 and above will be same.

Nifty at 7800:

1) 7900 CE is worthless: Loss: -13500
2) 7800 CE is also worthless: Profit: 10000
3) 8000 CE is also worthless: Profit: 4150

Total Profit: 10000 + 4150 – 13500 = 650

We have already calculated 7700 and below, the results will be same.

So what do you make out from this trade? This is one of the worst trades to try out. Agreed mostly you will make a profit, but one loss will take away nearly 7 months of profits (4350/650 = 6.7). I have not even added the brokerage to this profit of 650. 4+4 = 8 trades are involved to open and to close. Calculate yourself what kind of profits remains even if this trade is successful most of the times.

My advice: Stay away from such trades when risk-reward is pathetic and on top of that you may be hoping that Nifty is nowhere near the bought strike price during the expiry week.

How To Adjust A Short Call Butterfly:

This is also a set-and-forget trade. If you see profits (even a small one) on any day before expiry – it is advised that you close the trade because at any cost you should not take the maximum loss.

If you keep rolling over whenever Nifty comes near the bought calls strike – you will take a loss every time you do. Therefore rollover is not recommended.

You cannot wait till expiry as this trade can make a big loss on that day. Also you will not get good profits when Nifty is away from the bought calls strike price and expiry is not near. When you close it few days before expiry, you may make some money but that will be less than the max profit. On top of that, eight transaction will involve a lot of money in brokerage.

Therefore this is a trade better avoided.

Have you ever traded a Short Call Butterfly? I am eager to know the results.

Most traders who call me to inquire about my course tell me that they know how to trade a butterfly. In fact this is first of the many trades they tell me they know. Strange it seems, but it looks like most Indian retail traders love to trade butterfly. Well frankly butterfly trade is not as easy as it seems and contrary to what many traders believe, it is a trade where some kind of prediction is required. Technically therefore it cannot be considered a non-directional trade.

Personally I stay miles away from a trade that needs any kind of prediction.

Do not get me wrong – a butterfly trade can be very profitable if the stock behaves the way the trader wants it to, but for that matter which trade does not make money if the view of the trader was right?

Anyway lets discuss the long call butterfly trade:

Traders view: If a trader believes the stock/index will be trading in the near term in a very narrow range, they can initiate a long call butterfly trade:

1. Sell 2 ATM (at the money) Call Option
2. Buy 1 ITM (in the money) Call Option for protection, and
3. Buy 1 OTM (out if the money) Call Option for protection.

All of the above options should have the same expiry date and of the same stock or index. Note that since 2 options were sold, 2 were also bought for protection.

Risk: Limited
Reward: Limited

Just like any other trade I explain in my website let me take a live example. Nifty on 12-Aug-2014 closed at 7727. So let me assume that for the next few days until August expiry, Nifty will remain range bound and will expire at around 7700.

Lets do some paper trading. Here is 12-Aug-2014 closing prices rounded off:

28-Aug-14 CE 7,700.00 107.00 (ATM) – We sell 2 lots
28-Aug-14 CE 7,600.00 178.00 (ITM) – We buy 1 lot
28-Aug-14 CE 7,800.00 55.00 (OTM) – We buy 1 lot

Lets do the long call butterfly trade:

1. Sell 2 7700 CE: 107*50*2 = +10700
2. Buy 1 7600 CE: 178*50 = -8900
3. Buy 1 7800 CE: 55*50 = -2750

Total money debit: 10700-8900-2750 = -950. This is the maximum loss this trade can have.

Lets examine the results on the expiry day:

Scenario 1) Nifty expires at 7700:

7700 CE expires worthless: +10700
7800 CE also expires worthless: -2750
7600 CE loss 78 points: -3900

Total profit: 10700-2750-3900 = Rs. 4050.00

ROI: Assuming Rs. 60,000 was blocked as margin for the whole trade. (Rs. 25,000 approx is blocked as margin for selling one lot of option. For 2 lots approx 50,000 will be blocked plus one ITM option was bought for 8900 – so the figure 60,000 was reached.)

(4050/60000) * 100 = 6.75% returns in 16 days. Excellent returns considering the number of days. Note that such an expiry is rare. So the profit depends on where exactly Nifty expires. 6.75% return is a gamble. 🙂

Scenario 2) Nifty expires at 8000:

7700 CE is 300. Loss: 300-107 = 193 * 50 * 2 = -19300
7800 CE is 200. Profit: 200-55 = 145 * 50 = +7250
7600 CE is 400. Profit: 400 – 178 = 222 * 50 = +11100

Total profit/loss: 11100+7250-19300 = -950

Scenario 3) Nifty expires at 7400:

7700 CE expires worthless: +10700
7800 CE also expires worthless: -2750
7600 CE also expires worthless: -8900

Total profit/loss: 10700-2750-8900 = -950

Conclusion: The reward though limited in the call butterfly is excellent if the prediction goes well and the stock expires very near the sold options. The risk is less compared to the reward. Unfortunately even though the risk-reward ratio is good in a call butterfly trade, the problem with the trade is predicting where the stock will be on the expiry day.

As a trader I am extremely averse to trades that need me to predict the direction of the markets. This particular trade needs predicting, so I do not trade butterfly.

Note that one can also do a put butterfly trade using only the put options and the results will still be similar. But for some strange reasons traders usually trade butterfly using call options.

Adjusting the butterfly:

You can rollover the butterfly upwards or downwards as the stock moves, but every time you do it there is a chance of losing money. Therefore rolling over is not a good adjustment to a butterfly. On top of that it will involve eight trades in every adjustment. This is not a good way to trade options.

So the best adjustment is to take a stop loss.

Now in real world scenario. How many times do you think in a 30-day period a stock or index will be trading in a very tight range? I do not see it doing in any 30 day period. A big movement will come someday or the other and the trader will have no option but to take a stop loss. I will go on to say that if you take a stop loss with every 100 point movement in Nifty, then for sure you will take it 100% of the times. You can never make money taking a stop loss or rolling over in this strategy.

Then what is the best way to play long call butterfly?

Basically a butterfly is a set it and forget it trade. Since risk is very small compared to the reward, a trader can set the butterfly trade and leave it till expiry. You already know your max loss, and if you are comfortable losing that money – just do not adjust. On expiry day if you are lucky, you can make a decent return. That is why the long call butterfly is more a gambling than a trade.

Another idea is to play it only on the expiry week. Traders can get some idea on where the stock may expire and those are the options that you may sell. For five days Nifty may be in a very tight range and there are high chances that this trade may be profitable.

Note that risk-reward is the same even in the expiry week, so trading this in expiry week makes sense.

Short strangle is exact opposite of long strangle. I will discuss it soon but before that I would like to tell something. Since I started the options trading course many traders have called me. Most of the traders actually trade this particular trade and you know what, they lose money.

I feel bad when I see that most traders lose money. I can only see that the main reason is greed. You will soon learn that short strangle is such a trade that it will tempt you to be greedy. This is a trap and most traders fall for it. The results? They lose money.

How to Trade the Short Strangle?

In Short Strangle a trader will SELL an OTM (out of the money) call option and simultaneously SELL an OTM put option. Remember in long strangle a trader buys an OTM call option and an OTM put option.

IMP: The total lots sold for the call option should be equal to the total lots sold for the put option if you want a neutral Short Strangle.

Reward: Limited to the premium received
Risk: Unlimited. Let me warn you – losses can be severe.

In other words – we do not sell the call option to make money, also we do not sell the put option to make money. We sell call option as a hedge against the put option and we sell the put option as a hedge against the call option. Therefore lots of both the options should be same.

Now you should understand this – if the call option loses money, the put option makes money. And when does that happen? When the underlying goes up. Similarly if the put option loses money, the call option will make money. When does this happen? When the underlying goes down.

What happens if the underlying does not move? This is an excellent situation. Time will eat the premiums of both the call and the put option. If the underlying does not move much and remains range bound – both the options will expire worthless and the trader can keep the premium.

As you can see, at least one position always make money or both positions makes money. Good news right? Well this good news is actually a trap and many Indian traders fall for this trap.

They just sell both out of the money call and the put options. Next day when they see money in their account – they feel very good as if they have actually won the trade. Little do they realize that they are sitting on a hot tub and the day it gets overheated – they will burn their fingers.

Do not underestimate this trade. I used to trade this trade myself. Trades who trade Short Strangle know that getting returns of 15% or more per month is possible in this trade. Its a nasty trade, when all goes fine – its a superb trade, but when it does not work – it takes away all your profits made for the last few months and then some principal amount too.

When trades win, they think they are masters. And when they lose – they just blame it on luck.

3 months of laughter, and 1 month of destruction. Overall in 4 months time the trader looses money. Then he thinks OK, this was the last time I lost money and it will not happen again.

Unfortunately, the cycle repeats again and again. They remain where they were years back.

If you are trading Short Strangle you should always buy some protection on the call side as well as on the put side. In my course on trading options you will learn some hedging techniques that will help you to limit your losses.

Let me take a practical example:

Nifty is at: 7750.

So lets do a Short Strangle.

Lets sell OTM call strike price 8000 of August 2014 series. It is currently priced at: 38.00
Lets also sell OTM put strike price 7500 of August 2014 series. Currently priced at: 37.40

The total points received: 38+37.40 = 75.40.

Now lets calculate the break even point:

On the upper side:

8000 + 75.4 = 8075.40

On the lower side:

7500 – 75.4 = 7424.60

Which means if Nifty expires within this range: 7424.60 to 8075.40, then the trader will make money, or will at least not lose money.

It looks like a very easy trade. What is the probability that Nifty will go above 8075 and go below 7424 within the next 30 days? Yes today the chances of moving this much looks small, and the trade looks good. But I can guarantee you the situation will not be same after 10 days.

This is the trap. Traders think Nifty will not move beyond this as today it looks impossible. But when Nifty will move 100 points in a single day – the probability of moving beyond these limits will start to get bigger. If it actually goes there the trader will panic and take a stop loss.

It does not happen every time though. Sometimes both the options expire worthless and its party time for traders. Only if making money was so easy. 🙂

The fact is. It is not an easy trade. When Nifty starts to move in one direction, that side of the option starts swelling in value. The other side starts to shrink – but the problem is it can only shrink to 0. The trader has a limited profit there. After that the losses are unlimited.

How to adjust the Short Strangle trade?

1. One of the best ways is to take a stop loss. Once you take a stop loss – your losses cannot accumulate. Then enter the markets again when the picture becomes clear.

2. Another way is to buy options. But by the time you will want to buy an option for protection – you will see that the options have become very costly. But if you want to hedge, you have to buy it.

I can teach you some great hedging techniques in my Nifty Option Course. Using these hedging strategies you can make monthly income peacefully up to 5% a month. Contact me if you want to learn.

One day a trader from Bangalore called me and told that he does Short Strangles. I asked him what does he do when Nifty starts to move beyond his break even points? He told me then he buy/sell futures.

This is a bad adjustment. Why? What if the markets reverses from that situation? Future moves one point with every one point in Nifty. If next day Nifty opens against the future gap 200 points – 3-4 months of profits gone.

I asked him – do you make money. The answer was obvious – No. 🙂

3. Another good adjustment strategy is to rollover the position. Yes it is good, but the problem still remains. Most of the time when you adjust, you will lose money in Short Strangle. So you should try to rollover soon. In that case you will keep rolling over.

If you do not know what rollover means then it is closing the current position and at the same time or soon opening another Short Strangle of the next month expiry. Traders can also change the strike prices.

So you should know to create a level where you will either take a stop loss or rollover the position. When you rollover you should make sure you have made the trade somewhat natural. Which means the premium collected from the call side is equal to the premium collected from the put side.

This will make sure that profits equal the losses up to certain extend. Also you should try to book profits and exit the strategy as soon as possible as this is an unlimited risk strategy. For example if volatility drops you can make good profit in a few days. You should then exit the trade.

4. And the best adjustment advice: Do not get greedy and trade too many lots when trading Short Strangle. Yes receiving money the next day looks good, but your job is to protect that cash. You will be very worried if Nifty starts to move against your trade.

If you want to trade Short Strangle on Nifty I would advise never increase the lot size to more than two, I mean two lots on the call side and two lots on the put side.

5. Never trade them on stocks. Stocks can rise or fall 10% in 1 day. You may wipe out your account in matter of days.

Have you ever traded short strangle? What was your experience?