The Hindu Business Line : Index Strategy: Playing time value to your advantage

It is not uncommon to see stock prices and indices trade erratically during the derivative expiry week. While the volatility in the markets during such times may yield many profit opportunities, trading in options becomes unusually difficult, as the option premiums tend to erode. So while this would make buying current month options foolhardy, going long in the next month options too doesn’t appear very prudent now. Traders can therefore consider a short strangle. But before we go about it explaining it, it merits note that though this strategy limits your returns it involves taking significantly higher risk. And since it involves selling of options, there is a high margin requirement too. The strategy therefore may best be left for traders with a high-risk appetite and deep pockets.

The Spread

The short strangle can be set by selling Nifty Oct 5100 call that closed at Rs 19.7 and Nifty Oct 4900 put, which closed at Rs 20.9. The strategy would entail an initial credit of Rs 40.6 per share, which is also the maximum profit that can be made. The initial credit can be pocketed only if the index closes Thursday between the strikes prices of the options sold.

The strategy would turn out of money if Nifty breaches the upper or lower breakeven points. The breakeven for this spread can be calculated thus:

Upper breakeven: Call strike price + net premium received. In this case, it would be 5140.6. This means your spread would become loss making if Nifty moves beyond 5140.

Lower breakeven: Strike price – net premium received. In this case, the lower breakeven point would be 4860, breaching which the spread would be out of money.

Exit options

If anytime before expiry, Nifty breaches either of the breakeven points you can consider a premature closure of the spread to contain losses.

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