In this AliceBlue webinar, We will discuss a strategy that is derived from a statistical approach on both option buying and option selling researched over the last two years of data. With the current leverage from the broker, the ROI is pretty lucrative and the risk is well defined! Even better, You can Automate it.

The Basic 101

How to trade options in the stock market

Example – Justdial Bear Flag

Justdial had been in a downtrend and ended up making a bear flag. (In terms of concepts of bounce – It broke the downtrend and starting going up in a bullish sideways channel. We are calling it “bullish sideways trend” instead of uptrend because it is messy and not following the concepts of an uptrend in a clean manner.)

In the stock market, the first assumption is that – We do not know the direction of where it is going. We try to predict the direction but now, as you can see – We can also predict a range using options.

The concept of Range Betting is an important takeaway from this conversation.

Here are all possible altercations that are possible and monetizable from this chart if we’re to believe Justdial will move at least at “some” direction. (It can make unlimited Doji till month-end and at 400 only too! Right?)

We define “PRZ”. It is an acronym for Potential Reverse Zone.

There are 5 such points in this case as per our current perception. Different people will have different perception.

Broader Market has triggered a huge sell-off, So my perception is “not bullish”. Now, In futures, We can just short Justdial with stop loss but in the world of “options trading”, we have multiple options which are why this discussion!

Straddle

Refer – https://unofficed.com/lessons/straddle/

There is no loss between 330-470.

The range is marked with red lines.

But it will be a huge cause of headaches if it does a one-sided movement. We need to keep changing our strikes to reshape our range in which we will stay in profit.

What if We do not want to do that? We can bet on the same thing with a limited loss setup. If we are right, We will get less profit but we don’t have to micromanage or have fear of extreme losses!

This is Iron Condor.

Refer – https://unofficed.com/lessons/iron-condor/

Now there is no loss between 360-450

The range within which we were making a profit, contracted! The amount of profit is also contracted. The cost is quite steep for the insurance of sweet dreams.

Anyways, We were discussing neutral strategies. But our view is bearish.

Now we can just sell call options of ATM strike price i.e 400CE at 37.2

Or, We can also sell OTM strike price i.e. 500CE at 9.55

In a similar analogy, We can also buy ATM strike price of 400 PE at 31.55 or OTM strike price of 300 PE at 3.6

  • If we sell Justdial futures at 404.9, our profit will be unlimited (Well, highest profit can be 404.9 if Justdial goes 0.) **but we will start making a loss the moment Justdial trades above 404.9
  • But if we sell 400CE at 37.2, We can make a maximum profit of 37.2 but **we will start making a loss when Justdial trades above 437.2
  • 500CE sell at 9.55 is even worse in terms of reward i.e We can make a maximum profit of only 9.55 better in terms of risk i.e. **we will start making a loss when Justdial trades above 509.55

So, the Stock market is designed in a way that risk and reward are linear! The more risk you take, The more chances of money you make/lose!

  • The risk of options is always lower than the Risk of futures.
  • The risk of options is also lower than risk of equities.

Although, You can not short equities in India. Let’s say You buy Justdial at 404.9, we will start making a loss the moment Justdial trades below 404.9

Coming back to the original discussion – We can also introduce a limited loss set up in this case too. This is called call spread.

We will make limited loss if Justdial ends above 420.

Refer – https://unofficed.com/lessons/vertical-spread/

Because of permutations and combinations of payoff graphs due to multiple strike price and multiple expiries, Things can go literal creative and You can bet on many amazing things apart from “just range” or “limited loss” trades. You can explore the most popular strategies from the Unofficed website.

The Justdial chart is posted in Tview. You can use the “Make it mine” feature to use it and see the levels in more details –http://in.tradingview.com/chart/JUSTDIAL/rv1xkEz5-WatchList-Justdial-Pivot-Points/

The Option Greeks

Refer – https://unofficed.com/courses/the-option-greeks/

If you’re an options trader, you may have heard about “Greeks,” but perhaps you don’t know exactly what they are or, more importantly, what they can do for you.

It gives us a mathematical understanding.

Greeks are calculated using a theoretical options pricing model.

Delta, Gamma, Theta, and Vega – which are the first partial derivatives of the Black Scholes options pricing model are the more common ones.

As we’re going to discuss Intraday models. The most important greek of all here is – Theta.

The option’s theta is the rate of decline in the value of an option over time.

Selling options means having positive theta and buying options means we have negative theta.

In our case, Justdial 400CE is sold at 35.75 and the expiry is on 28th May, The theta is 946.73. It means We will get ₹946.73 if JUSTDIAL price and volatility remains constant tomorrow.

If Justdial expires at CMP i.e. 404.9, the Price of 400CE will be 4.9. We will make a profit of 35.75-4.9 = 30.85 points in that case. The lot size of the Justdial is 1400. So it is about 1400*30.85=43190 INR

We have 25 days to expiry. In that theory, we should have made 43190/25= 1727.6 by tomorrow instead of 946.73 right?

Wrong!

The effect of theta increases exponentially as the time to expiry comes near.

Takeaways

  • If we sell as soon as possible, the theta has more time to eat premium.
  • If we buy as late as we can, the theta has more time to eat premium.

But this is not true!! Because options are not just about “Theta”.

Options are insurances. Theta is all about the decline of risk of the insurance over time.

Lets forget about Direction as it is not in our hands.

Lets forget about Interest Rate because there are preplanned announcements from RBI’s side on interest rate decision and hence can be avoided.

Let’s talk about volatility.

On the start of the market, the volatility is at its peak.

It can be easily seen on the charts of India Vix too!

Lots of AMO order gets executed, people try to punch order due to FOMO or various reason. Its chaos.

Then, there is execution risk. The brokers also get stuck, so does the exchange. It is sort of herculean effort to execute trade on 9:15:00

Here comes the concept of Implied Volatility and Vega.

Implied Volatility is an estimate of expected movement in a particular stock or security or asset. It basically tells what the market is “implying” about the volatility.

It is derived from the price of an option in the market.

IV doesn’t define option prices. The option price defines IV. Supply and Demand creates option price.

IV of far OTM options can be way higher and IV of ATM options. There can be asymmetry. You can read further on volatility and its effect at https://unofficed.com/lessons/implied-volatility/

Vega is the change in the option price when the Implied Volatility of the underlying asset moves up or down 1%. Our profits/loss from IV collapse will be determined by Vega.

Volatility is calculated by a few things, namely –

  • Change on the price.
  • The speed at which the change in the price happened.
  • Historical Price changes. (If the markets have gapped down over three times in the last three days, there is a high chance it can gap down tomorrow as well, Right?)
  • Expected price movements. (Like Fundamental Events)

Read more here – https://unofficed.com/lessons/vega

All brokers start their intraday square off from 15:00. So, selecting a broker that allows you to keep the position to 15:20 will give an unfair advantage! Also windows for huge deals open from 15:00. This is another volatility.

Models

When we discuss some instruments, there has to be an approach. The approach can be unrelated to each other like ideas of Tradingview having multiple theories for multiple trades.

Also, the approach can be specific and model-based, quant-based, definitive. Lets talk about some definitive approaches over BankNIFTY and NIFTY weekly option selling

In weekly options, the impact of theta is more because the expiry is near!

In weekly options, the impact of vega is lower for the same reason as well!

But, as we are discussing intraday, option buying models will also have a lower impact of theta as they are closing the trade EOD anyways. Anyways, we shall discuss about option buying models later on.

There are lots of approaches

Machine Learning Models

An example can be seen here – https://towardsdatascience.com/stock-market-forecasting-using-time-series-c3d21f2dd37f

Stock market forecasting using Time Series

The stock market is designed to transfer money from the active to the patient.

– Warren Buffett

It takes past data, the Machine Learner gets trained. It’s like a human reading the data and processing it. And, based on that data it throws projection. It is pretty diverse. It can make a correlation model based on the movement of other indexes like Dax.

It can make short term pattern models, statistical models. The above link shows detail way to do Time Series analysis

Statistical Models

So, Machine Learning models are statistical models.The model we will discuss in through is also a statistical one.

Technical Models

SuperTrend Strategy based models.

Moving Average Based models.

Price Action based Models

L model – It takes SnR and does a quick sentiment analysis.

OI Based Models

The strategy discussed in the banknifty max pain page. Check there

Greek based Models

A strategy discussed in the volatility spread section. Basically you start from selling a straddle or strangle and keep balancing the delta.

There is nothing called a fundamental model because that is not something that can be defined or quantified. It’s like more of a gut feel. Gut feels can not be coded; otherwise, there would be lots of Ultrons or Javrises roaming around

Sentiment Analysis

Here is one interesting example

http://github.com/maxbbraun/trump2cash

This bot watches Donald Trump’s tweets and waits for him to mention any publicly traded companies. When he does, it uses sentiment analysis to determine whether his opinions are positive or negative toward those companies. The bot then automatically executes trades on the relevant stocks according to the expected market reaction.

The Extensive Backtest

This section has three parts.

A Systematic Approach On Option Buy With 10,000 INR

We have already discussed the first part. If you’re new read it

Second: The Straddle Model

Before we discuss about the perfect intraday option selling strategy, We need to talk about theta once more.

Theta will have the highest impact on the ATM strike prices because ATM strike prices are the riskiest and will have a high premium with it. So because of vega, their premiums will be inflated which can be eaten with Theta.

So, the strategy is to sell ATM Straddle at the time of 9:20 and with a stop loss of 20% per leg.

In case of a trending day, our one leg will hit SL and other leg will run and cover the loss and the strategy will end in profit.
In case of sideways day, it will be in tremendous profit.
Loss happens when there is zigzag!
Also total points is a dynamic thing. It is hard to define % wise. ATM straddle’s premium of current market and past market is different

Due to recent volatility, brokers keep changing the auto square off time. So we have chosen the exit price at 14:50

Like the previous strategy of options buy, We just discussed here, We did near 1200 possible combinations of backtest using python and ended up with two cases of exit time.

Type I is 14:50

Type II is 15:15

As discussed, Type II is more profitable than Type I. I will also share the python code and How-tos on Alice Webinar. (Unless I make paid course later on APIs as suggested on polls)

https://docs.google.com/spreadsheets/d/18A5gUXY3tWasfsQyfryhuj5HhoazOZS99HAnDElTcnQ/edit?usp=sharing

Type I and Type II has very less difference.

The story of reduction

Its about the knowledge of the fact that brokerage and other charges are huge shit.

Well, 90% of unofficed are on alice and no brokerage

Other charges make it near 100 INR per touch.

365 days

36500 INR.

Add slippage issue of same amount

So 73000.

Deduct that from net profit to get realistic figure.

Automate

Last part is Automate.

You guys know Alice bot. So telling not much here. I am making this slide for Alice only. In short, you can automate this stuff with both by mapping and writing straddle. You can read more about that at the Alicebot website.

May 5, 2020

INFO:root:{‘p’: [[‘BANKNIFTY2050720100PE’, [‘SELL’, ’20’, 541.1, 614.2, 1]], [‘BANKNIFTY2050720100CE’, [‘SELL’, ’20’, 517, 459.35, 1]]], ‘et’: [’09:19:00′, ’14:49:00′], ‘s’: ‘intraday’, ‘ed’: ‘1,0’, ‘sfm’: ‘false’, ‘sfd’: ‘1550188800000’, ‘std’: ‘1581910710191’, ‘slp’: ‘-21’, ‘so’: ‘leg’}
INFO:root:Current PL is -309.0

May 6, 2020