Option strategies are referred to as strategies that circle around risk management or help handle risk better. I haven’t come across anyone or any instance when someone highlighted a strategy that resulted in return accentuation.
So, we continue with the stereotype but this time let us discuss a few trades that are simple to execute and has a capacity to outperform the underlying stock or the index if deployed consistently over a period of time.
Money management requires having to know the potential to win and more importantly, the maximum capital which is at risk at all times. This exercise would essentially decide whether the trade is economically viable or not.
Now, in the current trading system, the definition of that maximum loss at risk takes another shape. We, by the virtue of our studies/analytics, are now capable of defining the extent of negative impact on our underlying that would negate the possibility of the expected forecast.
For example, we have taken stock named ‘A’ under observation. Once we narrow down on an expected-up move in the stock in the near-term, it is time to deploy the strategy.
Most of us are now mature enough to define that if Stock A holds a particular level at the lower end there is a possibility of an up move only to a particular price point.
So, the trade is defined -- we can now say that one can buy stock A at CMP, stop loss (CMP - X) and a target (CMP + Y). Here, Y is usually around two times X.
This sounds perfect. We have curtailed down the maximum risk exposure from buying price of the stock A to the mere difference between CMP and stop loss level.
The only concerns here that have pushed me into resorting to Known-Loss Strategies many years back are:
1. What if the stop loss level does not get traded and the underlying open a few rupees down below the stop loss
2. More importantly (this happened with me many times), what if the stock hits the stop loss and then turns around to hit our target.
The easier way to trade is with Know-Loss Strategy:
Strategies where one knows at all times what is maximum that can be lost without having to execute anything additional.
The ones that I resort to are simple Bull or Bear Spreads for a horizon of 10 sessions plus with most of the expiry yet to go by and Long (Buy) Call or Put typically in the week of expiry.
The benefits of these Know Loss Strategies:
1. I know what is maximum at stake, no need for stop losses to be triggered. This comes in very handy when there are gap downs
2. Since I am in trade till expiry despite any price move in the underlying after whatever amount of negative move if the underlying turns favourable, I am in trade to make money out of it.
The only issue that I have had with these strategies is the absolute profit out of them is a fraction of that of having a position in the underlying (via Cash or Future).
But, over the period of time, the risk containment feature of Known-Loss strategies has kept me glued to it as at the end it all adds up to make sure that such prudent strategies outperform the aggressive ones.
The author is CEO & Head of Research at Quantsapp Private Limited.
Disclaimer: The views and investment tips expressed by investment expert 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.
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