Shubham Agarwal
Every once in a while, there comes a time when we have a rather directionless market with indices meandering around similar levels for prolonged periods of time. Such times are generally celebrated by ‘Option writers’.
Historically we have seen that equities as an asset class have outperformed in a trending market, but it is equally important to learn an art of option writing, especially in the ‘non-directional’ one.
In fact, we talk a lot about diversification when it comes to the sectors and stock selection. Option writing is one such diversification that one should do from the trading portfolio perspective. It comes in handy when the market moves in a narrow range for a prolonged period of time.
If you remember equity markets were rangebound for some time after the 2008 meltdown, but option writing kept on getting decent returns almost till 2011.
This taught us how crucial the Options Writing could be as a trading portfolio diversification but along with that it also taught a very important lesson as well — it reduces the possibility of a big loss.
“While Writing Options There is a Very Thin Possibility of a Very Big Loss”.
We are talking about Non-Directional writing. Non-Directional writing is mostly the starting point for most of the Option writers.
In a lull phase that could stretch for one or two months, traders opt for selling both Call & Put. These lulls period can last long enough to get one hooked to it.
It is to make money out of writing without any mechanism in this lull period, but if one wants to make a full-time trade allocation to this exercise, then there has to be a mechanism in place, because once a trending move sets in, it could ruin a year-long pay-off in just a month.
So, here are a few tips and tricks that one should keep in mind while thinking of bringing Option Writing as a permanent part of your trading portfolio.
RULE 1: There are various tools in place from simple ones like Bollinger Bands (can be googled) or quite simply the Heaviest Call & Put open interest strikes to ballpark a trading range, use them to choose the strike rather than randomizing the strike selection.
Rule 2: Always have an exit strategy in place before entering (True for any kind of writing). Placing Stop Loss at Twice the Premium Received is a perfect staring point. Then there are underlying price triggers which a lot of writers follow.
Rule 3: One more way to keep yourself comforted is by trading neutral. This means while Options Writing makes a trade with net Sell position in the Options, many traders neutralize this by Buying farther Call and Puts. This saves us from any sudden Black Swan event when we do not get enough time to exit the trade. I am not saying there wouldn’t be loss, but it would be limited.
Option writing is finally an unlimited loss strategy, so we need to make sure that we keep it small till we get the grip. And if there is a fear of unknown loss might as well trade in accordance with tip #3.
(The author is CEO & Head of Research at Quantsapp Private Limited.)
Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
