Click below to play the video
Thanks for joining. Let’s start off.
How are options different from equity?
Options are derivative instruments – so you’re asking how options are different from equity. Options are derivative instruments which are based either on the index or on stocks and of course a lot many other underlying assets are there but essentially they are derivative instruments which have an underlying asset. So that’s how options are defined.
Options trading strategies – How to use Debit spreads
So I’ll be going through a few basic option trading strategies. It would be good if you know the basics but if you don’t know then do let me know so I can stop and explain wherever it is needed. Right so, option trading strategies – the thing that we are talking about today is how to use debit spreads.
There are various strategies using options and it is quite a bit, you know, options are quite a bit conducive wherein you can actually customize your positions based on what you want to do based on your view in the market. So that is something that can be done through options and so what we are doing right now is studying how to use one particular strategy which is known as the debit spreads. So let’s go ahead
What are option spreads?
This is what we will be talking about today. We will be talking about the basics of spread strategies and particularly two strategies which are bull call spread or it is also known as the call debit spread and the bear put spread which is also known as the put debit spread. And we’ll also at the end of it, we’ll try to take an example from the market on how to actually place these positions and how to actually you know understand when to place what. We will try to do at the very end. So let’s go to the basics of option spread strategies.
There are you know a few ways of buying options. One is that you buy a particular option let’s say you think that the market is going to go high and then you can buy the call option because the call option will move along with the market so the call option goes up when the market goes up you can buy a call option and if you buy a call option without any kind of a hedging it is known as a naked buy. Right so, we are not actually going to do a naked buy; we are not actually talking about the naked buy. We are trying to reduce the cost and minimize the risk and therefore we are using an option spread it’s not a naked buy, right?
So in the same way when your view is that the market is going to go down right so what you could do is that you know you could buy a put option. A put option again if you are not hedging it with anything it’s called a naked buy but again it is a risky proposition so by using option spreads we’ll hedge the risk.
What is an option spread? It’s a combination of different options or a combinations of buy and sell by which we actually reduce the cost and we also minimize the risk of option trading because option trading as you would know is actually pretty risky. Therefore you risk losing your capital if you are not aware about how they move and therefore what we are trying to do is by using an option spread that is a combination of one or two options, we are trying to reduce the cost and we are also trying to reduce the risk of option trading.
So what are option spreads? Simply speaking, they are simultaneous purchase and sale of two option strikes of the same underlying and expiration. It could be more than two depending on the strategies but right now what we’re talking about is a spread strategy which is done with the help of two option strikes of the same underlying asset. So let’s say if we are trading in nifty options so the same underlying assets means both the option have the same underlying. That is, both of them are based on the nifty index – the calls that we buy and sell are based on the nifty index: the same underlying and the same expiration.
Every option has an expiration date. So there’s a weekly expiration which happens on the Thursdays and also there is a monthly expiration which happens on the last Thursday of the month. So we want to buy options of the same expiration; both the options belonging to the same expiration. We’ll use for this option spread strategies.
Yeah in option trading do we need to know the option greeks – theta, gamma, delta, vega – for trading it is good to know, it is good to know but it is not actually necessary. Why I say that is because there are a lot of traders in the market who don’t know the option greeks but they are they are aware of the prices okay the way the price moves and they are able to do very good trades just by you know their understanding of how the price moves, right? But there are also equally good traders who have a very thorough knowledge of the option greeks and they are able to use them for you know very good trades and profitable trades. So if you are asking say is it compulsory, is it mandatory that we should know? No I don’t think so because there are many people who are doing it without a knowledge of the greeks but it is good to have an understanding of the greeks and how they will interplay on your trade so it’s good to know, okay? Is it making sense so far?
Yeah that’s good
When can a Bull call spread / Call Debit Spread be deployed?
Okay let’s move to the first category that we are talking about today which is called the bull call spread or you can also call it the debit call spread. Now why is it known as bull call spread; it is because this strategy is implemented when the market view is moderately bullish. So let’s say um let’s say that you know you have a bullish view of the market. What is a bullish view? You are thinking that the market is going to go up uh okay, that’s a bullish view and you are moderately bullish about the market so you are thinking it may not go very aggressively but moderately. You know it will go higher and that’s your view. So once you form the underlying view then we come to the strategy. So in in this kind of a view you can use what is known as the bull call spread or it is also known as the debit call spread. Why is it known as a debit call spread? It is because in this we will have a net debit premium which means we are actually paying something to get this strategy in place. So that’s why it is known as a debit call spread. Also a bull call spread or a debit call spread is what we will understand right now.
Okay now in a bull call spread what happens is that your risk is limited to the net premium paid. As I said you know there is a debit; there is a slight debit, so you are paying a cost and your risk is limited to that cost. Whatever happens in the market your risk is not going to be more than the net premium paid. So like what we said earlier the option spread strategy is actually used to control your risk. It’s used to minimize your risk so this is the aspect that we’re talking about. It’s limited to your net premium paid and whatever happens to the market, even if your view goes horribly wrong it will not matter because you know beforehand that your net premium paid is going to be the maximum risk that you’re going to take on this strategy. So that’s the great advantage of doing a spread strategy.
Okay uh so what’s the maximum reward? You can calculate the reward based on this difference in strike prices less the net premium paid. That is what is going to be your maximum reward you know you can calculate it that way so you are taking let’s say market is at 16500 right now. Nifty spot is at 16500 right now. You are taking a 16500 call and you are selling a 16700 call – so one call buy and one call sell, right? 16500 buy and 16700 call sell – the difference in the strike prices is 200 points and let’s say you have a net debit premium of 100 points okay so difference in the strike price is 200 points less than net debit 100 points, so 100 points is your maximum reward that you can take, okay? And hundred points on nifty means 100 points multiplied by the lot size 50; that’s 5000 rupees the reward that you can expect on this. Right?
Does this apply to day and swing trading; No by swing trading and day trading I assume that you are speaking about equity. No this is not that we are we are talking about in trading in options okay but as far as the view is concerned you take a view and if you have a market view of course you can use that view in your day trading and swing trading also so based on your view you choose what kind of instrument you want to take. If you want to go into options you know you can use this strategy or let’s say you don’t want to go into options, you want to use it in the cash market. You can also do that but basic thing is your view – what is the view about the market that you have.
And break even, what’s your break-even? It is the strike price of the buy call plus the net premium paid. That’s going to be your break-even point so this is what it is – buying a lower call strike and selling a higher call strike.
Example of Spread Strategy Deployment
What I’m saying right now is on the slides and we’ll try to look at the charts also and actually see how we can implement this thing, right? So what we are doing is that we are buying a lower call strike and we are selling a higher call strike? What does that mean? So uh it means that at present this the nifty is around 16500, so if we are buying a lower call strike let’s say we buy a 16500 call; our market view is bullish; we buy a 16500 call and we sell a higher call strike. We sell let’s say 200 points up so 16700, we sell.
So when we buy a lower call strike we are actually paying a premium. The option price includes a premium to buy that strike and when we sell the higher call we actually receive a premium when we are selling we receive something so we receive a premium from the 16700 call and whatever we have paid less what we have received is the net debit that we are having because we are buying a lower one we are actually paying a higher price and 16700 would have a lower price so we have a net debit that’s why it’s called a debit call spread.
Is there a strategy in options with very minimal risk? That’s what we are trying to do here uh you know. Instead of going with a naked buy, we are using a spread. Let me give you an example. Let’s say you are buying 16500 call and it is 375 rupees, okay? So 375 multiplied by 50 is your cost and that is also the maximum risk and if you’re buying a call and you’re doing nothing else it is called a naked call buy, okay? So your risk is 375 multiplied by the lot size which is 50 – that’s your cost and that is your maximum loss. Now what you do is that you sell a higher strike so let’s say you are selling a higher strike which is you know, let’s say 275 rupees. So what do you get? 275 you pay 375, the net debit is 100. So you know strategy with a minimum risk is what you have done.
What you’re doing is that you’re insuring against your own view in the sense that suppose my view goes wrong then instead of paying a higher price, I will pay in the maximum loss that I can bear is only a hundred. You’re also capping your profit but you are you know limiting your loss so for a risk averse trader it is a good strategy to have. So yeah, we are not betting against ourselves because we believe in our view and we want to believe but it is not that you know every time whatever you are thinking about the market will go right. So you have to take you know something which is known as insurance. If we are betting against ourselves, we would have to take the reverse strategy, right? My view is bullish but I take a bearish strategy. That is betting against yourself but insuring for your view, let’s say my view goes wrong, what should I do? Should I blow up my capital or should I take a loss that I can’t afford to take or should I settle for a lower loss? It depends on you.
Suppose there’s a very aggressive investor and they want to go all out. You’re welcome to do that you have the opportunity in the market but let’s say you’re a risk averse trader and you want to go slow, you want to go steady, there is also the option available for you in the market. For those who are beginners and those who are still kind of trying to steady their steps in the market, it is good to go slow and steady and gain your profits slowly, getting more knowledge. So maybe if you have more knowledge about the market and you are confident about everything, you can go totally aggressive. You have both the options available for you in the market. So what we’re doing right now is that we are not actually betting against ourselves but we are insuring against a wrong view, so if my view goes wrong I want some insurance, that’s what we’re doing.
So this is the example that I was just mentioning to you. It’s a bull call spread. These are the positions that we will take and this is a monthly expiry. You can see the expiry here is 31st march 2022. so it’s a monthly expiry right here okay both the positions are of the same expiry, that’s what I was talking about, it is the same expiry – you cannot take one monthly and one weekly. You are taking both options of the same expiry; you are buying a lower strike and you are selling a higher strike 16500 or 16600 – the market is at this level right now so I’m paying 375 and I’m getting 163 okay and the net debit – 375 minus 163 is the maximum loss that I will take on this trade. 375 minus 163 multiplied by the lot size 50 that will come to around this figure so, 10608 rupees is the maximum loss that I will take on the strategy.
What is the maximum reward that I can take on the strategy? It is the difference between the strike prices 16600 and 17100, which is 500 points difference – which difference minus the debit premium it will come to around this amount – 14392 is the maximum reward that I can get for the strategy.
Risk Reward Ratio
I have a risk reward ratio of 1 is to 1.36, fair enough yeah? I would like a better risk reward ratio but this is fair enough; 1 to 1.36 is the risk reward ratio that I am having on this trade so my market view is bullish and I am buying a lower call strike, I’m selling a higher call strike and the difference is the net debit and the maximum loss that I will be incurring on this trade, okay. Now when you say maximum loss just remember that this maximum loss is as on 31st March okay. Now it is not necessary that we stay in this trade till 31st march okay, it’s not necessary. We can we can exit before that if we go wrong. If we go wrong we can exit before that so you don’t have to wait till you get the maximum loss.
So if you’re getting a lower risk reward ratio, it is better to try out some other trade or rather not trade at all because what it means is that by taking that trade you are actually settling for a lower reward and if you go wrong on your view you are actually paying a higher price for going wrong. So if you’re getting a less than favorable risk reward ratio, it means that the setup right now is not favorable for your trade, so it is better to avoid that trade or try some other options wherein you can get a better risk reward ratio.
Bull Call Option Spread Payoff Graph
So this is how the payoff graph will look if you plot it and this I’ve used the site which is known as opstra and it’s a great site for option trading. You get this graphs and all greeks if you want. So this is how the payoff graph will look like and the break-even point is here. I want the market to move up; if the market moves down, the maximum loss that I’m going to face is 10000 rupees and the maximum profit that I’m going to have is somewhere around 14400. You see this blue line okay, you see this blue line – this is how it will go. The max profit and the max loss is as on 31st march, which is as on the day of expiry but this blue line is where it is going to travel before going to the final place so this for me is more important because I am not going to wait till I get 10 000 rupees loss if my view is wrong. I’m going to exit somewhere here and I’m not going to wait till I get a max loss of 10 000. I will exit somewhere here and that loss will be you know somewhere like maybe 2500 rupees or something. I’ll get out there okay and if I go up you know I don’t have to wait till I get 14300 you know. I may choose to have an exit right here. I might choose this as sufficient profit for me you know 7000 or 10000 whatever it is, this is sufficient profit for me to get out of this trade.
Determining Market View
How do you determine whether your view is wrong? If you’re making a loss, your view is wrong. So you know the basis of this trade is you know either you have to be bullish to have a bull call spread. When you’re saying you’re bullish it means you are expecting the market to go up. if the market is not going up, if the market is going down so it is against your view. So you know, that’s how you determine your view is wrong.
Managing Volatility and Option prices
Yes you can make a loss due to volatility but that is more pronounced if you are doing a naked call buy so what we have here is that uh you know you have one position as a buy and one position as a sell, so let’s say you know because you’re expecting the market to go up so in all probability the volatility is going to go down. If the volatility goes down, the option prices will come down. So if the option prices come down your sell position will cushion you against the decrease in volatility. So that’s why it is also more important, you can actually even manage your volatility based on the spread strategies. If the volatility goes down and so the option prices go down, and you’re doing a naked buy then you will incur greater loss than in a spread strategy. So even if even you are facing volatility fluctuations you can actually safeguard yourself using spread strategies better than naked strategies. So that’s also included in that.
So right now this is just a picture over here maybe let’s when we do that example I’ll show you the option greeks also so that will help you to understand the volatility part.
Bear Put Spread / Put Debit Spread
Okay now the opposite of this is bear debit spread or a put debit spread. Now this is when the market view is moderately bearish. It’s the total opposite of what we have talked about till now. Again the risk is limited to the net premium paid, reward is the same way you calculated. Breakeven also the strike price of the buy put minus the net premium paid that’s how you calculate the breakeven. You buy a higher put strike let’s say 16500 is the market right now. I am expecting the market to go down. I buy a 16500 put because I’m expecting the market to go down and I sell a lower put strike so I sell let’s say 16300 put strike, okay? When we wanted the market to go up I was telling 16700 but now we are on the other side so a lower put strike. Again the same thing – same underlying asset, same expiration, lowers the cost and lowers the risk.
Difference between Debit Spread and Credit Spread
Yes debit and credit spread. You see right here, so you’re buying a 16600 put which is 410 rupees so you are paying 410 okay and you are selling a 16100 put which is 225 rupees and so you are receiving 225. So there is a net debit – that’s why it is called as a put debit spread. Now you can do a credit spread also. Let’s say you are expecting the market to go down. You can sell a call – a higher call, the market is at 16500 and you are selling a 16800 call and you are buying 17000 call. If you do that, you will have a net credit. You will receive more and you will pay less so then it is known as a call credit spread because you are receiving a net credit from the strategy. But let me also warn you in a credit spread, although it is considered to be safer because your probability of profit will be higher, if you’re selling from far away, your risk reward ratio will not be favorable in a credit spread. So please if you’re entering a credit spread please check your risk reward ratio. Most of the times it is not favorable but your probability of profit will be much higher in a credit spread.
Okay so that’s the position. This is how the payoff graph will look. You want the market to go down and this blue line is what I would be looking at. I don’t want to wait for the max profit, I don’t want to wait for the max loss. I want to, as soon as my I’m taking my position, I want the market to go down and somewhere here I will book my profits and if I go wrong then I don’t want to wait for the max loss to happen but somewhere here I want to book my losses and get out of that position, okay?
Explanation of Option Greeks
So this is the opstra platform and this is the bull call payoff graph and you can see the option greeks over here right. You can see the net volatility status of the position. So what this means is that I have a positive volatility. So what this means is that if the volatility goes up I’m going to benefit and if the volatility goes down, I’m going to face a loss. So for those who want, you know, a thorough understanding of the option greeks you can have a look at this but what I wanted to say is that using a spread strategy you can manage your volatility. Yeah that’s what i wanted to say and okay here is the payoff graph and you can just plot this over here right and you can use this for understanding.
Option greeks are delta, theta, gamma, and vega. These names that are given. Delta is actually the rate of change in the option compared to the rate of change of the underlying asset. You know I’m not a mathematician so sorry if I’m not able to explain it very well but I can tell you the interpretation of this. I cannot tell you the calculation of it but this is what it is. Delta is the rate of change of the option price compared to the underlying price but it’s a dynamic figure okay it’s not a static figure. Theta is the time decay of the option because every option has an expiry so the closer it goes to expiry the value decays. Okay and at this moment of time this is the net decay position of your strategy. Okay gamma is actually the rate of change of delta; we don’t use it so much. It is the rate of change of delta but if you are trading very close to expiry then this is something that you want to look at okay. Vega is your volatility based on the volatility of the market, option prices increase or decrease so this is the effect that it is going to have on your position right. That’s in short what option greeks are.
As I said earlier, it is not absolutely necessary for you to become a mathematician. I am not. I know how to interpret the option greeks and I know how to manage my position based on the greeks. So for those of you who are more mathematically inclined, you can go and do the calculations and stuff but otherwise it is easier to just interpret okay.
Easy Method to Determine Market View
So this is this is uh the nifty chart and the last point that I wanted to tell you is how do you form a view of the market. You can just go to your trading account and let’s take a chart. We are taking the nifty chart and you can plot two moving averages okay. What I’m telling you right now is actually very simple and basic. This is for those who are beginners so if you already know how to take a view of the market then you know it’s fine but for those who don’t know I’m just giving you a very basic understanding of how you can form a view. What I understood till now of the market is that the simplistic you are, the better it is you know so simple things work that’s what I understood about the market till now. So don’t worry if it is not very complicated and all but this is you can take moving averages okay.
You take moving average 10 exponential moving average and you take a 20 period moving average also exponential so it will come out something like this and this is a one hour time frame okay. This is a one hour time frame and you can take this trade for let’s say two or three days max not more than that. So if you want to have a longer time frame for your trade you can go to one day and you know or the reverse is also true. So what you want to see about the market is let’s say here in this case you want to look at the crossovers. The 10-day moving average is crossing above the 20-day moving average so the market is turning bullish over here. I want to wait till I get a confirmation. I get a green candle and I get the next green candle which is going above that okay. I want to wait till that but the crossover is happening right here in this place and you can understand the market is turning bullish. But this is actually in this case you would have taken a loss because it didn’t go very high and then when it came down you would have to exit your position. But then if you go at it again you are saying that the crossover has happened here and again uh probably there is one stop loss over here, one loss over here but this will give you a greater profit because you know it went down so fast here. Right the crossover here the 10 moving average crossing below the 20 moving average that means it is the market is turning bearish and you take a bear put spread and you book your profits somewhere here right. And it is still not turned bullish again, so you don’t take a bullish trade, you wait for your confirmation candle. It is coming here you can take a bearish uh trade here so this is this is a very simplistic way of understanding where the market is moving for those who are beginners. I purposely have kept it very simple and it is good to have a simple understanding of the market and take your trades accordingly right.
Thank you and that’s what I wanted to talk about today. This are my connect points if you want to connect and if you have any questions I would like to answer them although I answered many questions along the way. If you still do have any questions we’ll take that now.
Questions and Answers
So geopolitical situation, you know, there are many ways of analyzing the market. One of the ways is to look at the macro view of the market, how is the economy functioning and things and like that. But what we are doing right here, we are not looking at the macro view. That’s not the method that we are using. The method that we are using is price and volume okay price and volume it is on the charts okay. So the moment you look at the chart. Any geopolitical thing that is happening or anything that is related to the economy happening, you will see it happening right in front of your eyes when the prices start to move down and your averages 10 ema and 20 ema they cross down. You know that the market is turning bearish. So there are many ways of analyzing the market – one of the ways is the macro view. So there are people who do that but what we just learned over here is simple technical analysis and you know looking at just the charts and the prices and anything that is happening overall in the system, in the economy in politics will be reflected in the prices, so you know you are covered for that.
I am a full-time trader yes.
How to take insight from volume. If you look at the nifty future charts you will also understand you can also take a volume and if you know the if the market is turning bullish with a higher volume there is a greater probability of the trend being continued or if the market is turning and if your crossover is happening with a higher volume again you know there is a higher probability of the market coming down. So greater the volume, greater the probability of the trend. So you can take that insight from volume but it will not show on the indices, it will show on the futures chart. So you have to look at it on the nifty futures chart.
Opstra is free and the free version is good enough for the beginners. I think that it’s a fantastic tool but they also have a paid version which gives you much more statistics, anything that you want to know.
Violet color okay yeah oh sorry you know that’s my personal preference. You can choose your own color okay. I like to use some aggressive colors for the fast moving average so I put red on the 10 and you know a darker color on the 20 moving average. So the violet is the 20 here and this is the 10 moving average yeah but it’s a personal preference. You can choose whatever colors you like. For those people who are more aesthetically inclined, you know you have all the color chart in front of you.
Okay I would like to connect with you. If you would like here are my connection points. If there are no more questions we’ll end it here.
10 and 20 EMA. 10 and 50 EMA would be too far apart and if we are using a one hour time frame for shorter term trades so 10 and 20 is what I’m using. If you’re using 50, 20 and 50 EMA it will be for a longer time frame; it should be for a longer timeframe that will be helpful if you are using it in the cash market.
Do I offer any training? Yes I do. Contact me and I can train you. In fact, I’m training right now.
Spread can you buy long term – long term would you define long term because ideally we don’t want to keep a net debit position for long in any case. Whatever expiry you’re buying let’s say you’re buying a monthly expiry 31st march then that’s the maximum that you can hold right. 31st march is the particular expiry that you’re buying and for nifty right now we have till December of the year, I think December of the year. So you know as many options are open before you can keep it there for the long term but I would advise you against it. Please don’t do that. It is better to operate in the cash market if you want to do long term.
Recording I think yes. Crater.club will be providing the recording. It will be on the crater website.
Predicting – No I don’t want to predict. I will just look at the chart and I will go according to the chart. The price and the volume is right there in front of you. I don’t want to predict. I want to take my positions based on what the chart is, so you know market may go up to 18000 market and go up to 20000. Market may go down to 15000. If it goes up I’m going to take a bullish position and if it goes down I’ll take a bearish position. On both sides I will trade, but I don’t want to predict. I will look at it and take my trade.
So yeah thank you everybody and thank you for asking all those wonderful questions. It was a joy sharing with you and we’ll keep sharing.
Thank you everyone