Author: shyam

Introduction

Straddles can be expensive. A slightly less expensive, but more bullish strategy is the strangle. Instead of ATMs in the case of the straddles, you buy a slightly OTM (out-of-the-money) put and a slightly OTM call.

May NIFTY 6750/6800 Long Strangle

With the NIFTY trading at ~6780, you buy the 6750 Put and the 6800 Call.

Strangles have a wider break-evens than straddles. So they are bigger bullish call on volatility than straddles. In this case, the break-evens are 6188.50 are 7361.50

Exiting the trade

Just like in straddles, time is not your friend here. You can either exit the trade right before the event occurs – when implied volatility is at its highest or soon after the event (irrespective of the magnitude of the movement.)

The lack of liquidity means that you are forced to put this trade on closer to expiry and that is exactly the time when θ-decay is at its highest. And the wider break-evens mean that movement in the underlying has to be larger for the trade to work.

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Introduction

While discussing the subject of the Long Straddle, we touched upon three things:

1. Most of the obvious uncertainties are priced in. So you better have a unique point of view.
2. Time is not your friend.
3. The lack of liquidity means that you are forced to put this trade on closer to expiry and that is exactly the time when θ-decay is at its highest.

What if you invert the trade? This is exactly what the short straddle is made of. You can enter this trade soon after an widely anticipated event occurs and implied-volatility is at its highest.

Construction

This strategy consists of selling a call option and a put option with the same strike price and expiration.

The θ-decay now works for you. Sell ATM nearest-expiration options, collect the carry and laugh all the way to the bank, right?

Not so fast! If the NIFTY breaks-out above 6836.50 or below 6663.50, then you are exposed to ∞ loss. It is up to you to figure out if the Rs. 4325.00 you are getting is enough compensation for insuring against the likelihood of that breakout.

Exiting the trade

Time is your friend and volatility is your enemy. When you sell insurance of this kind, you are exposed to external events that may not have anticipated and that occur outside of market hours. If you see volatility creep up, its best to exit this trade, even if at a loss.

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Introduction

If you are sure that the underlying stock/index is going to move strongly before expiration, then this is the option strategy for you. The move can be in any direction, as long as its violent. For example, you might be expecting an important court ruling, the outcome of which will be either very good news or very bad news for the underlying.

Remember that most of the obvious uncertainties are priced in. So you better have a unique point of view.

Construction

This strategy consists of buying a call option and a put option with the same strike price and expiration, making it relatively expensive. The options are struck ATM (at-the-money.)

With the NIFTY trading at ~6780, you can either buy the 6750 straddle or the 6800 straddle. Let’s walk through each trade.

May Nifty 6750 long straddle

Note the θ (-742.73) on the ITM call. Its a lot of time-decay if you are wrong. The model says that the market prices are too disjointed from the model price. Besides, the break-evens are 6161.00 and 7339.00 which means that you have to be absolutely convinced that something big is going to happen.

May Nifty 6800 long straddle

The θ situation has improved somewhat and the break-evens – 6217.20 and 7382.80 – look better. The trade costs Rs.29,140/- to put on and that caps your max-loss.

Exiting the trade

Time is not your friend here. You can either exit the trade right before the event occurs – when implied volatility is at its highest or soon after the event (irrespective of the magnitude of the movement.)

The lack of liquidity means that you are forced to put this trade on closer to expiry and that is exactly the time when θ-decay is at its highest.

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• Forensics: NIFTY Options – Implied Volatility(IV) (stockviz.biz)