Option traders face an uphill task, managing price, volatility
and time erosion. Various complex option trading strategies have evolved to
manage option trading risk but still,
formulating option strategies could be frustrating.
Though options are complex instruments for risk management,
they can be used effectively under any market conditions. Option offer,
flexibility, high leverage and limit the
risk.
Before we proceed, it is important to understand the various components in option pricing:
Delta is the amount an option price is expected to move
based on a $1 change in the underlying stock. Calls have positive delta,
between 0 and 1. Puts have a negative delta, between 0 and -1.
Gamma is the rate that delta will change based on a $1 change
in the stock price. So if delta is the “speed” at which option prices change,
you can think of gamma as the “acceleration.” Options with the highest gamma
are the most responsive to changes in the price of the underlying stock.
Theta, time decay, is enemy number one for the option
buyer. On the other hand, it’s usually the option seller’s best friend. Theta
is the amount the price of calls and puts will decrease (at least in theory)
for a one-day change in the time to expiration.
Vega is the amount call and put prices will change, in
theory, for a corresponding one-point change in implied volatility. Typically,
as implied volatility increases, the value of options will increase. That’s
because an increase in implied volatility suggests an increased range of
potential movement for the stock.
An advanced option
trader has highly sophisticated tools to trade in options where each of the
above component is analyzed. However,
for an individual it boils down to managing the intrinsic and time value of an
option. The intrinsic value of an option
moves in tandem with the price of the security whereas the time value works
against it as time progresses.
Hence it is important for an option trader to know the trend
force and its direction before trading in options. A strong trending move can
negate the effect of theta (time value erosion), keeping the option trader in
profit, even when close to expiry.
Trading naked options, if timed correctly, can become a
relatively risk free, simple and high profit strategy . An option trader using
the Triple Trend Oscillator (TTO) will be in a
position to judge the tend quality. The position of trend oscillators close to
zero indicate sideways moves which can kill an option trader. The best trend structures would be when the trends are placed away from
the zero line indicating strong trending move in either direction. Again the
position of the intermediate and minor trend would indicate the trend strength
and the trigger line could be used to take position in the direction of the major
trend.
Most options have monthly expiry cycle. Trading in options
with long term view (2- 3 months) requires high level of skills. Short term trades in the near month options
using hourly charts is the easiest way to
trade in options. Buying near month, in–the-money (ITM) or at –the-money (ATM),
naked call and put options using bullish and bearish alignment of trend
oscillators in TTO can be a simple but highly profitable option trading
strategy. Since the options buyer’s risk is limited to price of option he has
purchased, a favorable risk reward ratio and using tight risk management can
result in surprisingly good returns.
More on Trading F&O using TTO
The following charts show how bullish/ bearish alignment of trend oscillators in TTO can be used to trade naked options.
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| Source : National Stock Exchange, Mumbai |
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| Source : National Stock Exchange, Mumbai |
