Option selling has always been a lucrative trade. They say, more than six out of 10 options ever created have expired worthless (“0”). This creates a very strong case in favour of Sell Option trades. However, if Option selling is done without any filters, it can do a lot more harm than good.
As all of us remember that Selling Options come with a characteristic of unlimited or undefined loss. So, to be extra careful let us today see one such filter that can at least safeguard us from expected losses. There are always surprise moves that the market makes for which we must keep stop losses.
Here we will discuss how to identify the best time to sell Nifty options. To identify if it is the best time to sell or not we shall observe India VIX. Let us understand what India VIX is and why and how we use it as a filter.
What is India VIX?
India VIX, also referred to as risk index, is an index of Implied Volatility or Volatility Inputs used in pricing all Nifty options expiring in the near term.
These Volatility Inputs (also known as Implied Volatilities) are basically an indication of expected future volatility.
Why use India VIX as a filter?
India VIX gives us an indication of what kind of volatility the market is expecting in the coming days. As we all know, more volatility is bad for Option Sellers and less volatility is good. So, to judge if the expected volatility in the coming days is low or high, India VIX can be used as a filter.
How to use India VIX as a filter?
We want India VIX to be downward trending or stable for us to avoid any expected risk of loss due to high volatility in our Sell Option trade. With India having one of the highest numbers of Technical Trend Analysts in the world, I don’t think I need to explain much on how to identify the trend.
However, for those who may not have the expertise a simple indicator may just do the job. Getting a chart of India VIX is not that difficult. Just add a 20-day moving average on top of it. If India VIX is trading above the 20-day moving average, the index is trending up meaning the expected volatility could be more and more.
So, a simple rule is whenever we have India VIX trading above the 20-day moving average, we will not initiate or hold a sell option trading position.
The impact of this will be:
- 1. We will have fewer opportunities to trade, as we will not initiate the trade in times when there is high expectation of volatility.
- 2. We may have to exit a trade early (with lower profits) if India VIX starts trading above the 20-day moving average.
Now, the same technique can be used for individual stocks also. There are various platforms that provide charts of Implied Volatility of individual stocks. Those charts can be used with moving average to create filter for individual stocks as well.
Finally, this does not mean that we should not keep a stop loss. Stop Loss in Sell Option trade is a must because let us not forget that the market can behave in a completely opposite direction to our expectation.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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