- By SAURABH MISHRA
Nifty options have a life of 20 days in a month.That is the longest period of active trading in their theoritical life of 90 days.Normally we see current month strikes trading at good volume and other two strikes will see very less activity.One reason may be the uncertainity of the market in the short run.While most of the experts on media say confident things about India’s long term story most of them remain clueless on what is going to happen in near future or in short term.This short term uncertainity is shown in options trading volume too.Not many traders will find themselves confortable with valuing options of next month and there are no long term options available on nifty.Fundamental analysis is ruled out from options trading because of this reason only.There is almost no way one could make use of a fundamental news in options trading.Because by the time that news become public and show its effect on options there is a time decay causing decrease in option’s value.Sometimes even a good move in spot market doesn’t give much boost to options because that good move is not taken seriously.
Most difficlut thing to gauge is what will drive the value of options up or down.Hence options trading remains only a momentum trading activity where positions are taken to benefit from the very short term moves in spot prices.Fundamental analysis is not about momentum it focuses more on value.Momentu is a technical phenomena hence technical analysis is of utmost importance if one is to become a good options trader.There are books depicting pay-off diagrams and claiming certain strategies to be risk less and a sure shot in any kind of markets.But when one trades those strategies in real they are too costly and out of reach for a normal trader.One has to have a lot of money to make use of these easy moves.But even then there is no real guarantee of them being a real riskless move.
With my experience I can say that trading in nifty options is best done with a very short term view.But it doesn’t mean intraday trading.It takes some time before a move in spot drives options.Major swings in options prices are seen once the move in spot is reffered to as correct move.Suppose there is a steep rise in nifty in a day but the overall market sentiment is not certain in this case if the next day is also an uptrend day one can see a jump in options price in following day.So before options traders certify a move as a right move in right direction there will not be much change in options.In other words this is checkd by using DELTA.Delta tells what change will be seen in options based on a change in spot.Technical analysis is handy in the sense it lets you identify the move and momentum of nifty in real time.This real time information and analysis is the key here.
When you trade in options you have to keenly follow the moves of the underlying.That is the only information you need and to make predictions and projections about the reaction of these moves you will need technical analysis.Now we take a look at how underlyings affect their derivatives.Suppose nifty starts the day will a few points gap up and consolidates,this gap up move is not going to reflect upon options instantly.It will take time and the longer nifty stays in consolidation the stronger the rise in options will be.If there is a gap up and suddenly it gets filled in by a downmove, more often you will see that options will not gain much from this move.They are more likely to depend on negative news and lose value.Too much volatility is not going to help call options.When nifty opens up many traders will like to buy calls thinking the move will continue.Here a better trader will wait till the consolidation comes.Once nifty crosses over the consolidation period and continues with the upmove these experienced traders will take their positions.Any which way real rise in options will be seen only after the consolidation confirms the earlier upmove.If there was an opposite move after a weak consolidation then those who took positions at the begining of the upmove will lose money.So the lesson is to avoid the jump.
Don’t jump into calls or puts.Let the spot market move subside and see if the spot is still showing good signs then only initiate a position in calls or puts.No point taking those neutral positions where you buy calls and puts at the same time for the same strike.Another observation is that because of time decay any option is more likely to be favoring negative moves then positive moves.So each time an option price goes down it will take a bigger move then previous move to get it back to the old level.Another way of saying this is a 200 point move in nifty for three days in a row will make call and put options increase and decrease differently each following day.Take any in-the-money call option and check out how it behaves on continuos upmove of nifty.First upmove is least likely to bring a change in delta however if the second day also shows a supporting move then delta will show good rise and options premium rise fast.Trading in option is more like speculating so untill the move is clear there won’t be much noise about it.
Options trading is active for 20 days in a month and then one has to change the outlook for the underlying and the way one trades.At each level of any underlying it will have a different level so its derivatives are going to be different also.Never fix a method to be your ultimate tool.There has to be a constant upgradation.Option trading is where you don’t have to know the future if you know what you are doing at present.
Wednesday, June 11, 2008
Option Time Decay
Because of one-series trading nature of options in our market time decay becomes a very crucial factor.Normally when you buy a stock you can give it time to perform what you expect from it.In the case of options once you take a position you will not want it to move in opposite direction.The reason is that you can not hold this option like a stock.There is an expiry date and in the run up to that date options lose value.Each day options lose value because they keep getting closer to the expiry which means that if you happen to initiate a trade and it goes wrong you might face a time crunch where your option will have no time to come to the right side and give profit.However this time decay can be used for good too.Time decay gives good returns if one is short on an option.See it like this,nifty is at 5300 and you write 5400 call with only 10 days to expiry.In the present market it is least likely that nifty will touch it.So you happen to pocket the premium on the trade.As expiry comes and if nifty is not holding up good that will decrease the price of this call option.Now when there is a sizeable market you can exit.In case nifty does make an upmove just hold on to your position.Because these options are cash settled there is no worry of exercise.But make sure that you have written deep out of money strike.If you write an in the money strike you will be held in the court for committing suicide.Anyways,when you write a deep out money call option in this kind of market it will take a very very strong move by the nifty to get that stike in the money.So here each negative move is in your favor and each passing day will also give value to your profits becuase time decay will decrease value of that option.
Suppose you took position in the same strike as above but this time you are long on call.Now you want nifty to move up.What works against you is any negative move of nifty and time factor.As days go by there will be a lesser chance for the strike to become in the money.And ultimately you will lose value if nifty doesn’t perform like the greatest bull market ever.There are two ways to tackle time decay.One,you ignore it.Second,you follow it.You ignore it when you go long on any option be it call or put.And you follow it when you go short on options.Here it is interesting to notice that time decay works on both call and put options.Normally what causes calls to lose value gives a boost to put value and vice versa.In case of time decay it cuts value from both of them at the same time.Only difference is the outlook of the market.Calls and puts both will lose value based on time decay and what the overall market perception is like.Because at one time market can favor either call or put.So whichever is favored will lose lesser than the other one.Using time decay is simple to read but difficult to execute.It will take in issues like margin and good relations with your broker.Your broker must be someone who is ready to help you.There are some rules on shorting a security regarding margin and other such protective measures and these can only be followed if you have a good broker backing you up.
Another observation I have made is in the beginning of a month its running series will do good and not much of time decay will be seen.In this kind of situation shorting can be dangerous.Rather wait for the last week to start.In the last four days there is no buying pressure or at-least very less buying taking place.This is the perfect time to initiate a short position.Collect your money to provide for margin and short the options.You will see that as the focus of trading shifts from running month series to next series there will be only decreasing moves in running options.They are close to expiry and now people are liquidating them.So no fresh buying.This will give you ample returns.In case trade goes wrong.Stay on as long as you can.The chances of odds coming back to your favour are high.
Options depend on their underlyings,this is where they gain value from.Sometimes when market is moving in one direction be it up or down its easy to trade options.Trading options in choppy market is most difficult because there is no direction in underlyings and hence no view on future levels.This kills options faster than anything else.Common known facts say that a market trends only 30% of the time,rest is a choppy market condition.In sideways moving market trading for the time decay is very useful.Very oftne you will see that index starts with gap up or down then moves back in and takes some small swings both ways and finally closes with almost or very small change from previous closing.This kind of day will not give any boost to premiums.Both calls and puts will lose value.Here if one goes short on an option then one has atleast got one factor on his side.He will be gaining from time decay.If market doesn’t become a trending one overnight and keeps on moving sideways there will be a good chance that this short will be exited with a profit.
Suppose you took position in the same strike as above but this time you are long on call.Now you want nifty to move up.What works against you is any negative move of nifty and time factor.As days go by there will be a lesser chance for the strike to become in the money.And ultimately you will lose value if nifty doesn’t perform like the greatest bull market ever.There are two ways to tackle time decay.One,you ignore it.Second,you follow it.You ignore it when you go long on any option be it call or put.And you follow it when you go short on options.Here it is interesting to notice that time decay works on both call and put options.Normally what causes calls to lose value gives a boost to put value and vice versa.In case of time decay it cuts value from both of them at the same time.Only difference is the outlook of the market.Calls and puts both will lose value based on time decay and what the overall market perception is like.Because at one time market can favor either call or put.So whichever is favored will lose lesser than the other one.Using time decay is simple to read but difficult to execute.It will take in issues like margin and good relations with your broker.Your broker must be someone who is ready to help you.There are some rules on shorting a security regarding margin and other such protective measures and these can only be followed if you have a good broker backing you up.
Another observation I have made is in the beginning of a month its running series will do good and not much of time decay will be seen.In this kind of situation shorting can be dangerous.Rather wait for the last week to start.In the last four days there is no buying pressure or at-least very less buying taking place.This is the perfect time to initiate a short position.Collect your money to provide for margin and short the options.You will see that as the focus of trading shifts from running month series to next series there will be only decreasing moves in running options.They are close to expiry and now people are liquidating them.So no fresh buying.This will give you ample returns.In case trade goes wrong.Stay on as long as you can.The chances of odds coming back to your favour are high.
Options depend on their underlyings,this is where they gain value from.Sometimes when market is moving in one direction be it up or down its easy to trade options.Trading options in choppy market is most difficult because there is no direction in underlyings and hence no view on future levels.This kills options faster than anything else.Common known facts say that a market trends only 30% of the time,rest is a choppy market condition.In sideways moving market trading for the time decay is very useful.Very oftne you will see that index starts with gap up or down then moves back in and takes some small swings both ways and finally closes with almost or very small change from previous closing.This kind of day will not give any boost to premiums.Both calls and puts will lose value.Here if one goes short on an option then one has atleast got one factor on his side.He will be gaining from time decay.If market doesn’t become a trending one overnight and keeps on moving sideways there will be a good chance that this short will be exited with a profit.
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