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When Should You Buy Options


Since the last few months Nifty is range bound and I am sure traders who have taken my course would have definitely made money. There are many strategies that are made for a range bound markets. Please read and follow your favorite strategy for such times.

Unfortunately last few months were pretty bad for option buyers because there was no clear trend expect once when Nifty fell down almost 600 points. After that the story is range bound and no real clear trend for buyers. Let me tell you that historically Indexes behaves this way only leaving little opportunity for option buyers to make money.

The Reserve Bank of India (RBI) will most likely leave its benchmark interest rate unchanged at 7.50 percent at tomorrow’s ( 7 April, 2015) policy meeting. It may also reduce it by 25 basis. We don’t know. But what we know is that Volatility will take a beating.

India VIX today is at 16.91, I can bet by the time trading ends tomorrow it should be lower than this. Remember historically the average VIX is around 15, and if no major news comes in June, I think the VIX will go back to mean.

Its going to be even more tough time for option buyers. If you are really keen in buying, then my suggestion is that wait till the news is out and let the VIX settle down. Once it does the direction will be clear and like always Nifty should move in that direction for a couple of days. But option buyers should remember that they are against time and Volatility. If what they are predicting does not come true, they should quit in couple of days.

If you are not in profits, hoping that markets will move as per your trade is not an answer. Option buyers, unlike option sellers do not have time and its for their benefit that they understand this and quit if markets do not favor them. When they favor, we all know that making 100 points is quite easy.

So lets make a trade plan for trades who love to buy Nifty Options. Note that real scenario may be different and you must make your trade plan according to your own experiences.

We are assuming a situation where the trader always buys ATM (at the money) options. I personally feel though they have the maximum time value, it is the at the money options that has the balance of being reasonably priced and appreciate quickly if the trade is favorable. OTM (out of the money) options do not move as fast as you may want them to due to low delta, and unfortunately may not make a substantial profit when you are right. Out of the money options are the ones who will bleed you to huge losses overtime. ITM (in the money) options on that other hand are very costly and though they have delta more than .5, they also lose money pretty fast if the stock goes against your view.

All in all, the At The Money options are your best candidate for buying. They are highly liquid too.

With the above in view lets chart out a plan for trader who buys options.

After a few paper trades (should be done for at least 3 months) you find that every 4th time you get lucky and make a quick 100 points profits. You are targeting 30 points a month, and you also take 4 trades a month. Note that 30 points a month is around 3% per month for seller, but for buyer its a lot of money (almost 20% we will soon see how.)

For example its 24 days to go for the June 2015 expiry (expiry is on 25th June 2015). The ATM call option (CE 8,400.00) today closed at 152.40. We take 150 as average.

If you make 30 points on this (though every time the price will change, we are assuming 150 to be average) profit is: 30 * 25 = 750. Cost to buy = 150*25 = 3750. ROI (750/3750)*100 = 20%

I hope 20% a month is good enough for any trader, even the worst of Greedy traders. πŸ™‚ Some traders have an amazing mindset. A few days back I got a call from one such trader from Assam. When I told him my course will help him learn to make 3% a month, he said this is too less and he is not interested in my course. I then asked him the obvious – how much per month are you making now? He said he is losing money. πŸ™‚

See the mindset. A trader losing money, but not satisfied or interested in making 3% a month. I am sure if he makes 10% a month in one of those lucky months, he will take a bigger risk the very next month to try to make 20% and lose it all. Greed never makes money. Greed has no limits. Greed is a killer.

Ok back to topic. We were making trade plan for the option buyer. 20% by the way is huge money a month, and I don’t think there are many traders who have achieved that feat over 5 years of trading.

If your target profit in a lucky trade is 100 points and your target is to make 30 points in a month, you can lose a maximum of 100-30 = 60 points in the remaining 3 trades. So in three trades you can lose 60/3 = 20 points. We got our stop loss. You take a trade and take your stop loss at 20 points max. But please note that for this to work you have to win 1 trade out of 4 and make more than 60 points to survive the game. You can also tweak your plan to make it smaller.

For example if you are taking a stop loss at 10 points then you can take your profits out at (10*3) + 30 = 60 points. For a 60 point profit for the At The Money option with delta of 0.5, Nifty has to move approx 100 points FAST – say 2-3 days. Remember after the option goes into the money, the Gamma changes the Delta and it also increases to more than .5, so a 120 point move is not required. Moreover if Volatility increases, you may not even need 100 points.

But in the above strategy, hope has no place. You will have to take a stop loss if the trade did not go according to the plan.

When should you buy options?

Traders do not know when to buy options. Well here are a few pointers:
1. Buy options when the news is out, volatility has crushed and direction is clear.
2. Buy well before (at least 7 days), when a major news is awaited. You must exit though before the news and volatility gets reduced. You may take another trade after the news. In a situation like this the long strangle works better.
3. Buy when you are absolutely sure of the direction, whatever the case may be.

When to Exit?

Exit when the target profit is achieved, or
Exit when your stop loss gets violated.

But make sure you have a plan and you are making the same points of profits and same points of losses as per your plan. Stick to your plan. Do not alter in every trade, you will then lose money.

Your plan should be based on the fact that option buyers win 1 out of 4 trades.

Remember even if you make 10 points a month as an option buyer, that is more than 6% a month and is a great return for any trader. In real world its very hard to make even 5% a month consistently for a long period of time.

Other Important Notes:

Suppose you met the target of 60 points in your first trade in the month, now is there any need to try another trade that month until some really great event is happening? If you speculate thinking you are at no risk, you will lose 10 points and take a few more trades and you end up making the same 10-20 points that month. This is foolish. The idea is to use these points as a hedge for next month’s trade. So please do not trade that month.

Like this if you have 3 months (absolutely possible) of 60 points each in a year, you will have an excellent return that year.

How to Compound This?

This is quite tricky as its very hard emotionally to buy naked options even worth Rs.50,000. At the back of his mind the trader knows that it may go to zero. Losing 50,000 in one trade is not a great idea, but hey we are taking a stop loss right? Keep that in mind – buying will get easier.

But how on earth you will get courage to buy options worth Rs.2 lakhs even with a 20 point stop loss? Yes it is very difficult, and it is the major reason why I hate buying options. In fact this is the major reason why majority of the option buyers lose money. They make a profitable trade by buying options worth 5,000 then immediately afterwords they buy options worth 50,000 and end up losing much more than the money they made in previous trades.

What Is The Way Around this?

You need to take the stairs, not the lift. For example for the next 6 months decide to buy options worth Rs. 5000. Then increase this amount to Rs. 6000 for the next 3 months. If successful take additional risk of Rs. 2000, and then after 12 months of successful trading make it Rs. 10,000/-. You got the point. Increase your risk slowly overtime.

Another way is to sell some out of the money options as a measure of hedge. Oh I love hedging. This reduces risk, but it also reduces profits when you are right. The idea here is that you need to make a plan. And this is only possible once you start paper trading or put small money on risk when you actually decide to trade with real money.

After a few trades you will know the answer to this: Should you go for naked option buy or hedge it by selling out of the money option. Only you can answer this – so go and do some trading.

Full Disclosure: This is not as easy as it sounds. For example you have to be correct in every fourth trade and get your maximum points as per the plan. You can reduce the profitable trades to from 60 to 30 points, but then the points for the stop loss trades also gets reduced and thus they do not get enough room to move and hit stop loss pretty fast.

You should therefore practice and come out with a plan of your own and just not copy what is written here. This is a guide for option buyers who speculate and lose money. Hope this article helps option buyers.

Note: In reality option traders almost always lose money. For one trade to win out of 4, your timing has to excellent and you may need some luck too with direction. In my course you will learn how to sell option and hedge it properly. You also do not have to predict the the direction of the markets. Mostly you win, and those small occasional losses can be taken care of. Click here to read more about the course.

Wishing you the Best.

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Hi, I am Dilip Shaw, owner of this website. I am a trader like you. I have been trading since 2007, but lost a lot of money till 2010. I then stopped trading and studied options like college exams. Started trading again from 2011 and never looked back since. I did a lot of research, read books and did countless paper-trading before being profitable. You can read about me here.

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About the author: I started trading stock markets since 2007. However my first 3 years were losses. Then I dedicated almost 1 year on studying, researching, paper trading options and learned a lot in that time. Since 2011 I am trading Nifty options profitably. Call me if you need any help trading options on 9051143004.

{ 3 comments… add one }
  • Ravinder singh sandhu April 23, 2016, 6:49 am

    Well shaw

  • prateek yadav July 5, 2017, 1:47 pm

    mr shaw , can u please explain how 30 points in nifty makes a return of 3 percent a month .

    • Dilip Shaw July 7, 2017, 5:08 pm

      For option seller margin blocked one lot Nifty 75 lot size = Rs. 35,000. 30 points = 30 * 75 = 2250 / 35000 = 0.064 * 100 = 6.4% ROI (Return on Investment). Hope clear. This article was written when Nifty lot size was 25, now its 75 so returns have actually increased.

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