Put ration back spread

September 27, 2022August 1, 2022 by Rohansharma

Background of Bear call ladder

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ration Back spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

4.1 – Background of Bear call ladder

In this module’s chapter 4, we covered the “Call Ratio Back spread” strategy in great detail. Similar to the Call ratio back spread, the Put ratio back spread is used by traders who are bearish on the market or a particular stock.

This is essentially what will happen when you use the Put Ratio Back Spread.

Unlimited profit if the market goes down
Limited profit if the market goes up
A predefined loss if the market stays within a range

Simply put, you profit whether the market moves up or down. Of course, the strategy is more advantageous if the market declines.

The Put Ratio Back Spread is typically used for a “net credit,” which means that money starts to arrive in your account as soon as you execute the strategy. In contrast to what you anticipate, the “net credit” is what you earn if the market rises (i.e market goes down). On the other hand, if the market does indeed decline, you will profit indefinitely.

This should also clarify why purchasing a plain vanilla put option is preferable to the put ratio back spread.

4.2 – Strategy Notes

As it involves purchasing two OTM Put options and selling one ITM Put option, the Put Ratio Back Spread is a three-legged option strategy. This is the standard 2:1 combination. The put ratio back spread must actually be executed in a 2:1 ratio, which means that two options must be purchased for every one option sold, or three options must be purchased for every two options sold, and so on.

Let’s use the Nifty Spot at 7506 as an example. You predict that Nifty will reach 7000 by expiration. This is unmistakably a pessimistic expectation. The Put Ratio Back Spread should be used if:

Sell one lot of 7500 PE (ITM)
Buy two lots of 7200 PE (OTM)

Make sure –

The Put options belong to the same expiry
Belong to the same underlying
The ratio is maintained

The trade set up looks like this –

7500 PE, one lot short, the premium received for this is Rs.134/-
7200 PE, two lots long, the premium paid is Rs.46/- per lot, so Rs.92/- for 2 lots
Net Cash flow is = Premium Received – Premium Paid i.e 134 – 92 = 42 (Net Credit)

Situation 1: The market closes at 7600 (above the ITM option)

Both Put options would expire worthless at 7600. Following are the intrinsic value of options and the ultimate strategy payoff:

7500 PE would also expire worthless, but we have written this option and received a premium of Rs.134, which in this case can be retained back. 7200 PE would also expire worthless, but since we are long 2 lots of this option at a cost of Rs.46 per lot, we would lose the entire premium of Rs.92 paid.
134 – 92 = 42 is the strategy’s net payoff.
Keep in mind that the strategy’s net payoff at 7600 (higher than the ITM strike) is equal to the net credit.

The market expires in scenario 2 at 7,500. (at the higher strike i.e the ITM option)

Both options would expire worthless at 7500 because neither would have any intrinsic value. As a result, the reward would be comparable to the reward we discussed at 7600. As a result, the net strategy payoff would be Rs. 42. (net credit).

In actuality, as you might have guessed, the strategy’s payoff at any point above 7500 equals the net credit.

The market expires in scenario 2 at 7,500. (at the higher strike i.e the ITM option)

In actuality, as you might have guessed, the strategy’s payoff at any point above 7500 equals the net credit.

The entire premium paid, or $92, will be lost because the 7200 PE has no intrinsic value.
Therefore, we would lose 92 on the 7200 PE while making 92 on the 7500 PE, resulting in no loss and no gain. As a result, one of the breakeven points is 7458.

Scenario 4 – Market expires at 7200 (Point of maximum pain)

This is the point at which the strategy causes maximum pain, let us figure out why.

At 7200, 7500 PE would have an intrinsic value of 300 (7500 – 7200). Since we have sold this option and received a premium of Rs.134, we would lose the entire premium received and more. The payoff on this would be 134 – 300 = – 166
7200 PE would expire worthless as it has no intrinsic value. Hence the entire premium paid of Rs.92 would be lost
The net strategy payoff would be -166 – 92 = – 258
This is a point where both the options would turn against us, hence is considered as the point of maximum pain

5.3 – Strategy Generalization

Based on the scenarios discussed above, we can draw a few conclusions:

Technically speaking, this is a ladder and not a spread. The first two option legs, however, produce a traditional “spread” in which we sell ITM and buy ATM. It is possible to interpret the spread as the difference between ITM and ITM options. It would be 200 in this instance (7800 – 7600).
Net Credit equals Premium collected from ITM CE minus Premium paid to ATM and OTM CE
Spread (difference between the ITM and ITM options) – Net Credit equals the maximum loss.
When ATM and OTM Strike, Max Loss occurs.
When the market declines, the reward equals Net Credit.
Lower Strike plus Net Credit equals Lower Breakeven.
Upper Breakeven is equal to the sum of the long strike, short strike, and net premium.

Take note of how the strategy loses money between 7660 and 8040 but ends up profiting greatly if the market rises above 8040. You still make a modest profit even if the market declines. However, if the market does not move at all, you will suffer greatly. Because of the Bear Call Ladder’s characteristics, I advise you to use it only when you are positive that the market will move in some way, regardless of the direction.

In my opinion, when the quarterly results are due, it is best to use stocks (rather than an index) to implement this strategy.

5.4 – Effect of Greeks

I assume you are already familiar with these graphs. The following graphs demonstrate the profitability of the strategy taking into account the time until expiration; as a result, these graphs assist the trader in choosing the appropriate strikes.

The best strikes to choose are deep ITM and slightly ITM, i.e., 7600 (lower strike short) and 7900, if you expect the move during the second half of the series and you expect it to happen within a day (or within 5 days, graph 2). (higher strike long). Please take note that this is an ITM and ITM spread rather than the traditional combination of an ITM + OTM spread. In actuality, none of the other combinations work.

Graphs 3 (bottom right) and 4 (bottom left): The best strategy is to use these graphs if you anticipate a move during the second half of the series and that it will occur within 10 days (or on the expiry day, graph 4).Deep ITM and slightly ITM strikes, such as 7600 (lower strike short) and 7900, are the best options (higher strike long). This is in line with what graphs 1 and 2 indicate.

The relationship between the change in “premium value” and the change in volatility is shown by three coloured lines. These lines make it easier for us to comprehend how an increase in volatility affects the strategy while keeping the time until expiration in mind.

Green line – This line suggests that, although not as much as in the preceding case, an increase in volatility is advantageous when there are roughly 15 days until expiration. As we can see, when volatility rises from 15% to 30%, the strategy payoff increases from -77 to -47.

Red line: Clearly, the premium value is not significantly affected by an increase in volatility as time approaches expiration. This indicates that when expiration is approaching, you should only be concerned with directional movement and not much with volatility variation.

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Bear call spread

August 1, 2022 by Rohansharma

Bear Call Spread

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ration Back spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

8.1 – Choosing Calls over Puts

The Bear Call Spread is a two-legged option strategy that is used when the market outlook is “moderately bearish,” similar to the Bear Put Spread. In terms of payoff structure, the Bear Call Spread is comparable to the Bear Put Spread, but there are some differences in terms of strategy execution and strike choice. The Bear Call spread entails using call options rather than put options to create a spread (as is the case in bear put spread).

At this point, you might be asking yourself why one would choose a bear call spread over a bear put spread when the payouts from both spreads are comparable.

Strategy Notes

To be honest, a lot will depend on how appealing the premiums are. The Bear Call spread is executed for a credit, as opposed to the Bear Put spread, which is executed for a debit. Therefore, if the market is at a point where –

The markets have rallied considerably (therefore CALL premiums have swelled)
The volatility is favorable
Ample time to expiry

Invoking a Bear Call Spread for a net credit instead of a Bear Put Spread for a net debit makes sense if you have a moderately bearish outlook for the future. Personally, I favour strategies that offer net credit over those that offer net debit.

8.2 – Strategy Notes 2.0

The Bear Call Spread is a two leg spread strategy traditionally involving ITM and OTM Call options. However you can create the spread using other strikes as well. Do remember, the higher the difference between the two selected strikes (spread), larger is the profit potential.The Bear Call Spread is a two leg spread strategy traditionally involving ITM and OTM Call options. However you can create the spread using other strikes as well. Do remember, the higher the difference between the two selected strikes (spread), larger is the profit potential.

Using the bear call spread requires:

Buy 1 OTM Call option (leg 1)
Sell 1 ITM Call option (leg 2)

Ensure –

All strikes belong to the same underlying
Belong to the same expiry series
Each leg involves the same number of options

Let us take up example to understand this better –

Date – February 2016

Outlook – Moderately bearish

Nifty Spot – 7222

Bear Call Spread, trade set up –

Pay Rs. 38 as a premium to purchase a 7400 CE; keep in mind that this is an OTM option. This is a debit transaction because money is being taken out of my account.

Selling the 7100 CE will earn you Rs. 136 as premium; keep in mind that this is an ITM option. This is a credit transaction because I receive money.

Since the net cash flow is positive (136 – 38 = +98), my account has a net credit as a result of the difference between the debit and credit.

A bear call spread is also known as a “credit spread” because, generally speaking, there is always a “net credit” in them. The market may move in any direction and expire at any level after we place the trade. In order to understand what would happen to the bear put spread at various levels of expiry, let’s consider a few scenarios.

The market expires in scenario 1 at 7,500. (above the long Call)

Given that we paid a premium of Rs. 38 for 7400 CE, which has an intrinsic value of 100, we would be in the black by the amount of 100 minus 38, or 62.
The intrinsic value of 7100 CE would be 400, and since we sold this option at Ra.136, we would have suffered a loss of 400 – 136 = -264.
A net loss of -264 + 62 = -202 would result.

The market expires at 7400 in scenario two (at the long call)

The 7100 CE would have intrinsic value at 7400 and would therefore expire in the money. The value of the 7400 CE would expire.

7400 CE would expire worthless, hence the entire premium of Rs.38 would be written of as a loss.
7100 CE would have an intrinsic value of 300, since we have sold this option at Ra.136, we would incur a loss of 300 – 136 = -164
Net loss would be -164 -38 = – 202

Be aware that the loss at 7400 and 7500 are comparable, indicating that the loss is capped at 202 above that point.

The market expires in scenario 3 at 7198. (breakeven)

7198 is regarded as a breakeven point because at this price, the trade is neither profitable nor unprofitable. Let’s look at how these numbers turn out.

The 7100CE would terminate at 7198 with an intrinsic value of 98. Since we sold the option for Rs. 136, we get to keep a portion of the premium, or 136 – 98 = +38. 7400 CE would expire worthless, so we would forfeit the premium, or 38.
This demonstrates unequivocally that at 7198, the strategy is neutrally profitable.

Situation 4: The market closes at 7100 (at the short call)

Both of the Call options would expire worthless at 7100, making them both worthless and out of the money.

7100 will also have no intrinsic value, so the entire premium received, or Rs. 136, will be retained back. 7400 will have no value, so the premium paid will be a complete loss, or Rs. 38.
136 – 38 = 98 would be the net profit.

It is obvious that the strategy generates a profit as and when the market declines.

8.3 – Strategy Generalization

We can generalise the strategy’s key trigger points based on the aforementioned payoff:

Spread: 7400 minus 7100, or the difference between the strikes, is 300.
Net Credit is calculated as Premiums Paid – Premiums Received (136 – 38 = 98).
Lower strike plus Net Credit 7100 + 98 = 7198 to reach breakeven.
Net Credit = Maximum Profit
Maximum Loss: Spread – Net Credit (300 – 98) = 202

At this point, we can sum the Deltas to determine the overall position delta and determine how sensitive the strategy is to directional movement.

I obtained the following Delta values from the BS calculator:

7400 CE has a delta of +0.32 and is an OTM option.
Since we are short 7100 CE, the delta is -(+0.89) = -0.89 since 7100 CE is an ITM option with a delta of +0.89.
Position delta overall is = +0.32 + (-0.89) = -0.57.
The strategy’s negative delta means that it makes money when the underlying value decreases and loses money when the value increases.

8.4 – Strike Selection and impact of Volatility

The graph above explains how the premium varies with respect to variation in volatility and time.

The blue line suggests that the cost of the strategy does not vary much with the increase in volatility when there is ample time to expiry (30 days)
The green line suggests that the cost of the strategy varies moderately with the increase in volatility when there is about 15 days to expiry
The red line suggests that the cost of the strategy varies significantly with the increase in volatility when there is about 5 days to expiry

It is obvious from these graphs that when there is enough time before expiration, one shouldn’t be overly concerned about changes in volatility. However, between the series’ midpoint and its expiration, one should have an opinion on volatility. The bear call spread is best avoided if you anticipate a decrease in volatility; otherwise, it is advised to use it only when an increase is anticipated.

Bear put spread

September 29, 2022July 27, 2022 by Rohansharma

Bear put spread

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ratio Back Spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

7.1 – Spreads versus naked positions

Over the last five chapters, we’ve discussed various multi-leg bullish strategies. These strategies ranged to suit an assortment of market outlooks – from an outrightly bullish market outlook to a moderately bullish market outlook.

Reading through the last 5 chapters you must have realized that most professional options traders prefer initiating a spread strategy versus taking on naked option positions. No doubt spreads tend to shrink the overall profitability, but at the same time spreads give you greater visibility on risk. Professional traders value ‘risk visibility’ more than profits. In simple words, it’s a much better deal to take on smaller profits as long as you know what would be your maximum loss under worst-case scenarios.

Spreads have another intriguing feature in that there is always some form of financing involved, with the sale of one option funding the purchase of another. In actuality, one of the primary characteristics that set a spread apart from a typical naked directional position is financing. The strategies you can use when your outlook is neutral to strongly negative will be covered in the following chapters. These strategies share characteristics with the bullish strategies that we covered earlier in the module.

The Bear Put Spread, which is, as you might have guessed, the inverse of the Bull Call Spread, is the first bearish strategy we’ll examine.

4.2 – Strategy Notes

The Bear Put Spread is similarly simple to use as the Bull Call Spread. When the market outlook is moderately bearish,

that is, when you anticipate that the market will decline in the short term but not significantly, you would use a bear put spread. A correction of 4-5 percent would be appropriate if I were to quantify what “moderately bearish” means.

If the markets are correct as anticipated (go down), one would make a modest profit by using a bear put spread; however,

if the markets go up, the trader would only suffer a small loss.

A conservative trader (read as a risk-averse trader) would implement the Bear Put Spread strategy by simultaneously –

Buying an In the money Put option
Selling an Out of the Money Put option

The creation of an ITM and OTM option for the Bear Put Spread is not required. Any two put options can be used to create the bear put spread. The trade’s level of aggression affects the strike decision. But keep in mind that both options must have the same expiration date and underlying. Let’s look at an example and various scenarios to see how the strategy operates in order to better understand the implementation.

Nifty is currently trading at 7485, which means that 7600 PE is in the black and 7400 PE is out of the money.

To use the “Bear Put Spread,” one would have to sell the 7400 PE, and the premium they would receive from doing so would help to pay for the 7600 PE.

In relation to the 7600 PE, the premium received (PR) is Rs. 73, and the premium paid (PP) is Rs. 165.

This transaction’s net debit would be –

We need to take into account various scenarios in order to comprehend how the strategy’s payoff functions under various expiry conditions. Please keep in mind that the payoff occurs at expiration, which means that the trader must hold these positions until expiration.

Situation 1: The market closes at 7800 (above long put option i.e 7600)

In this instance, the market has increased despite expectations that it would decline. Both of the put options at 7800, 7600, and 7400, would have no intrinsic value and would therefore expire worthlessly.

We would keep nothing because the premium we paid for 7600 PE, which was Rs. 165, would become 0.
The premium for the 7400 PE, or Rs. 73, would be kept in full.
Therefore, at 7800, we would experience a loss of Rs. 165 on the one hand, but this would be partially offset by the premium received, which is Rs. 73.
-165 + 73 = -92 would be the total loss.

Please take note that the ‘-ve’ sign next to 165 denotes a money outflow from the account, while the ‘+ve’ sign next to 73 denotes a money inflow into the account.

Additionally, the strategy’s net debit is equal to the strategy’s net loss of 92.

Scenario 2 – Market expired at 7600 (at long put option)

Here, we’ll assume that the market expires at 7600, the price at which we bought the Put option.

Then, at 7600, both the PE for 7600 and the PE for 7400 would expire worthless (similar to scenario 1),

resulting in a loss of -92.

Scenario 3 – Market expires at 7508 (breakeven)

7508 is halfway through 7600 and 7400, and as you may have guessed I’ve picked 7508 specifically to showcase that the strategy neither makes money nor loses any money at this specific point.

The 7600 PE would have an intrinsic value equivalent to Max [7600 -7508, 0], which is 92.
Since we have paid Rs.165 as a premium for the 7600 PE, some of the premium paid would be recovered. That would be 165 – 92 = 73, which means to say the net loss on 7600 PE at this stage would be Rs.73 and not Rs.165
The 7400 PE would expire worthlessly, hence we get to retain the entire premium of Rs.73
So on hand, we make 73 (7400 PE) and on the other, we lose 73 (7600 PE) resulting in a no loss no profit situation

Hence, 7508 would be the breakeven point for this strategy.

Scenario 4 – Market expires at 7400 (at short put option)

This is an interesting level, do recall when we initiated the position the spot was at 7485, and now the market has gone down as expected. At this point, both options would have interesting outcomes.

The 7600 PE would have an intrinsic value equivalent to Max [7600 -7400, 0], which is 200
We have paid a premium of Rs.165, which would be recovered from the intrinsic value of Rs.200, hence after compensating for the premium paid one would retain Rs.35/-
The 7400 PE would expire worthlessly, hence the entire premium of Rs.73 would be retained
The net profit at this level would be 35+73 = 108

The net payoff from the strategy is in line with the overall expectation from the strategy i.e the trader gets to make a modest profit when the market goes down.

Situation 5: The market closes at 7200 (below the short put option)

Again, this is an intriguing level because both possibilities would be valuable in and of themselves.

Let’s determine whether the numbers add up.

The intrinsic value of the 7600 PE would be equal to Max [7600 -7200, 0], which is 400.
After paying back the premium of Rs. 165 that we paid, which would be recovered from the intrinsic value of Rs. 400,

one would still be left with Rs. 235.
The intrinsic value of the 7400 PE would be Max [7400 -7200, 0], which is 200.
We were given a premium of Rs. 73, but we will have to forfeit it and take a loss in excess of Rs. This equals 200 – 73.

7.3 – Strategy critical levels

From the scenarios discussed above, we can generalize the following:

If the spot moves above the breakeven point, the strategy loses money, and if it moves below the breakeven point,

it makes money.
The profits and losses are both limited.
The spread is the variation in the two strike prices.
Spread in this case would be 7600 – 7400 = 200.
Net Debit = Premium Paid – Premium Received, which is 165 – 73, to equal 92.
Higher strike – Net Debit 7600 – 92 = 7508 is the breakeven point.
Max profit is equal to Spread – Net Debit (200 – 92) (108).
Maximum Loss = 92 Net Debit

All of these crucial details can be seen in the strategy payoff diagram:

7.4 – Quick note on Delta

It’s better late than never: I should have included this in the earlier chapters. Every time you use an options strategy, add up the deltas. I calculated the deltas using the B&S calculator.

7600 PE’s delta is -0.618.

-(-0.342)

+ 0.342

Now, since deltas are additive in nature we can add up the deltas to give the combined delta of the position. In this case,

it would be –

-0.618 + (+0.342)

= – 0.276

The ‘-ve’ denotes that the premiums will increase if the markets decline, giving the strategy an overall delta of 0.276.

Similar to the Bull Call Spread, Call Ratio Back spread, and other strategies we’ve discussed in the past, you can add up their deltas and see that they all have a positive delta, indicating that the strategy is bullish.

It becomes very challenging to determine the overall bias of the strategy—whether it is bullish or bearish—when there are more than two option legs. In these situations, you can quickly add up the deltas to determine the bias. Additionally, if the sum of the deltas to zero, the strategy is not particularly biased in any direction.

7.5 – Strike selection and effect of volatility

The strike selection for a bear put spread is very similar to the strike selection methodology of a bull call spread.

0 I hope you are familiar with the ‘1^st half of the series’ and ‘the 2^nd half of the series methodology. If not I’d suggest you kindly read through section 2.3.

Have a look at the graph below –

Choose the following strikes to create the spread if we are in the first half of the series (ample time before expiry) and anticipate a market decline of about 4% from current levels:

The premium varies according to changes in volatility and time, as shown in the graph above.

The blue line indicates that when there is enough time before expiration, the cost of the strategy does not change significantly with the rise in volatility (30 days)
When there are roughly 15 days until expiration, the green line indicates that the cost of the strategy varies moderately

with the rise in volatility.
The red line indicates that with approximately 5 days until expiration, the cost of the strategy varies significantly with the rise in volatility.
These graphs make it obvious that when there is enough time before expiration, one shouldn’t worry too much about changes in volatility. However, one must possess a view of the volatility between the series’ midpoint and its expiration. Only use the bear put spread if you anticipate an increase in volatility; otherwise, avoid using the strategy if you anticipate a decrease in volatility.

4.3 – Strategy Generalization

Going by the above-discussed scenarios we can make a few generalizations –

Spread = Higher Strike – Lower Strike
Net Credit = Premium Received for lower strike – 2*Premium of higher strike
Max Loss = Spread – Net Credit
Max Loss occurs at = Higher Strike
The payoff when the market goes down = Net Credit
Lower Breakeven = Lower Strike + Net Credit
Upper Breakeven = Higher Strike + Max Loss

Here is a graph that highlights all these important points –

4.4 – Welcome back the Greeks

Before understanding the graphs above, note the following –

The nifty spot is assumed to be at 8000
The start of the series is defined as any time during the first 15 days of the series
The end of the series is defined as any time during the last 15 days of the series
The Call Ratio Back Spread is optimized and the spread is created with 300 points difference

The market is predicted to increase by about 6.25 percent, or from 8000 to 8500. In light of the move and the remaining time, the graphs above indicate that –

Top left on Graph 1 and top right on Graph 2 – The most profitable strategy is a call ratio spread using 7800 CE (ITM) and 8100 CE (OTM), where you would sell 7800 CE and buy 2 8100 CE. This is because you are at the beginning of the expiry series and you anticipate the move over the next 5 days (and 15 days in the case of Graph 2) Do keep in mind that even though you would be correct about the movement’s direction, choosing other far OTM strikes call options usually results in losses.

Graphs 3 and 4 (bottom left and bottom right, respectively) – A Call Ratio Spread using 7800 CE (ITM) and 8100 CE (OTM) is the most profitable option if you are at the beginning of the expiry series and anticipate the move in 25 days (and expiry day in the case of Graph 3). In this scenario, you would sell 7800 CE and buy 2 8100 CE.
You must be wondering why the number of strikes is the same regardless of the time remaining. In fact, this is the key: the call ratio back spread functions best when you sell slightly ITM options and buy slightly OTM options with plenty of time left before expiration. In actuality, all other combinations are in the red, particularly those that include far OTM options.

In actuality, none of the other combinations work.

Graphs 3 (bottom right) and 4 (bottom left): The best strategy is to use these graphs if you anticipate a move during the second half of the series and that it will occur within 10 days (or on the expiry day, graph 4). Deep ITM and slightly ITM strikes, such as 7600 (lower strike short) and 7900, are the best options (higher strike long). This is in line with what graphs 1 and 2 indicate.

Three colored lines show the relationship between the change in “net premium,” or the strategy payoff, and the change in volatility. These lines give us insight into how an increase in volatility affects the strategy while keeping the time until expiration in perspective.

The blue line indicates that a rise in volatility with plenty of time left before expiration (30 days) is advantageous for the

call ratio back spread. As we can see, when volatility rises from 15% to 30%, the strategy’s payoff increases from -67 to +43. This obviously implies that when there is enough time before expiration, in addition to being accurate about the direction of the stock or index, you also need to have a view of volatility. Because of this, even though I believe the stock will rise, I would be a little hesitant to use this strategy at the beginning of the series if volatility is higher than average (say more than double the usual volatility reading)

Green line – This line suggests that, although not as much as in the preceding case, an increase in volatility is advantageous when there are roughly 15 days until expiration. As we can see, when volatility rises from 15% to 30%, the strategy payoff increases from -77 to -47.

Red line: This result is intriguing and illogical. The strategy is negatively impacted by an increase in volatility when there are only a few days left until expiration! Consider that a rise in volatility near the expiration date increases the likelihood that the option will expire in the money, which lowers the premium. So, if you are bullish on a stock or index with a few days left until expiration and you anticipate that volatility will rise during this time, proceed with caution.

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Synthetic long & Arbitrage

September 27, 2022July 27, 2022 by Rohansharma

Synthetic long & Arbitrage

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ration Back spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

6.1 – Background

Imagine being forced to open up long and short positions on Nifty Futures that expire in the same series at the same time. How, and more importantly, why, would you go about doing this?

Both of these issues will be covered in this chapter. Let’s first examine how this can be accomplished, then move on to consider why someone might want to do this (if you are curious, arbitrage is the obvious answer).

Options, as you may already be aware, are extremely flexible derivative instruments that can be used to create any type of payoff structure, including the payoff structure for futures (both long and short futures payoff).

As you can see, the long futures position started at 2360, and since you can’t make money or lose it at that point, it turns the starting point of the position into the breakeven point. If the futures move higher than the breakeven point, you are in the black, and if they move lower than the breakeven point, you are in the red. The amount of profit you make on a move of 10 points upward is exactly equal to the amount of loss you would experience on a move of 10 points downward. The future is also referred to as a linear instrument due to this linearity in the payoff.

The goal of a Synthetic Long is to use options to create a long future payoff that is similar.

4.2 – Strategy Notes

It’s fairly easy to carry out a Synthetic Long; all one needs to do is –

Invest in the ATM Call Option
Vendor Sell ATM Put Option
When you do this, you must ensure that:

The options share the same underlying asset.
has the same expiration
To better understand this, let’s use an illustration. Assuming the Nifty is at 7389, the ATM strike would be 7400. Synthetic Long would require us to short the 7400 PE at 80 and go long on the 7400 CE, which carries a 107-rupee premium.

The difference between the two premiums, or 107 – 80 = 27, would be the net cash outflow.

Consider the following market expiry scenarios:

Situation 1: The market closes at 7200 (below ATM)

Intrinsic value of Put Option = Max [Strike-Spot, 0]

= Max [7400 – 7200, 0]

=Max [200, 0]

= 200.

Clearly, since we are short on this option, we would lose money from the premium we have received. The loss would be –

80 – 200 = -120

The total payoff from the Long Call and Short Put position would be –

= -107 – 120

= -227

Scenario 2 – Market expires at 7400 (At ATM)

Both options would expire worthless if the market closes at precisely 7400.

We forfeit the 107 premium that was paid for the 7400 CE option.

We keep the premium for the 7400 PE option, which is 80.

The combined positions’ net payoff would be -27e 80 – 107.

Keep in mind that 27 is also the strategy’s net cash outflow and the difference between the two premiums.

Scenario 3 – Market expires at 7427 (ATM + Difference between the two premiums)

7427 is an interesting level, this is the breakeven point for the strategy, where we neither make money nor lose money.

7400 CE – the option is ITM and has an intrinsic value of 27. However, we have paid 107 as premium hence we experience a total loss of 80
7400 PE – the option would expire OTM, hence we get to retain the entire premium of 80.
On one hand, we make 80 and on the other, we lose 80. Hence we neither make nor lose any money, making 7427 the breakeven point for this strategy.

6.3 – The Fish market Arbitrage

Both of the call options, 7600 and 7800, would have zero intrinsic value and would therefore expire worthless.

The premium, which amounts to Rs. 201 for the 7600 CE, is ours to keep; however, we forfeit Rs. 156 for the 7800 CE, leaving us with a net reward of Rs. 45.

Situation 3: The market closes at 7645 (at the lower strike price plus net credit)

If you’re wondering why I chose the level of 7645, it’s because this is where the strategy break even is.

7600 CE’s intrinsic value would be:

Spot – Strike Max [0]

= [7645 – 7600, 0]

= 45

Since we sold this option for 201, the option’s net profit would be

201 – 45

On the other hand, we spent an additional 156 to purchase two 7800 CE. We lose the entire premium because it is obvious that the 7800 CE will expire worthless.

The net payoff is:

156 – 156

= 0

6.3 – The Fish market Arbitrage

I’ll assume you have a fundamental knowledge of arbitrage. Arbitrage is the practice of purchasing assets or goods at a discount and then reselling them at a higher price in order to profit from the price difference. Arbitrage trades are almost risk-free when properly executed. I’ll try to give you a straightforward illustration of an arbitrage opportunity.

Assume you reside near a coastal city where fresh sea fish is in plentiful supply; as a result, the price of fish is very low in your city, let’s say Rs. 100 per kg. The same fresh sea fish is in high demand in the nearby city, which is 125 kilometers away. However, the same fish costs Rs. 150 per kg in this neighboring city.

Given this, if you can buy fish in your city for Rs. 100 and sell it in the neighboring city for Rs. 150, you will undoubtedly pocket the difference in price or Rs. 50. Perhaps you’ll need to factor in logistics and transportation costs and only get to keep Rs. 30 per kilogram instead of Rs. 50. This is still a fantastic deal, and this is a typical fish market arbitrage!

If you can buy fish from your city for Rs. 100 and sell it in the neighboring city for Rs. 150, deducting Rs. 20 for expenses, then Rs. 30 per KG is a guaranteed profit with no risk.

If nothing changes, there are no risks involved. However, if circumstances change, your profitability will as well. Here are some potential changes:

No Fish (opportunity risk) – Let’s say you go to the market one day to buy fish for Rs. 100 but there isn’t any to be found. Then you have no chance of earning Rs. 30.
No Buyers (liquidity risk) – You purchase a fish for Rs. 100 and travel to a nearby town to sell it for Rs. 150 when you discover there are no buyers. You are left with nothing more than a bag of dead fish.
Negative bargaining (risk of execution) The fact that you can “always” bargain to buy at Rs. 100 and sell at Rs. 150 is the basis for the entire arbitrage opportunity. What if you happen to buy at 110 and sell at 140 on a bad day? You must still pay 20 forThe arbitrage opportunity would become less appealing, and you might decide not to do this at all if this continued. transport, this means that instead of the usual 30 Rupee profit you get to make only 10 Rupees.

No Fish (opportunity risk) – Assume one day you go to the market to buy fish at Rs.100, and you realize there is no fish in the market. Then you have no opportunity to make Rs.30/-.
No Buyers (liquidity risk) – You buy the fish at Rs.100 and go to the neighboring town to sell the same at Rs.150, but you realize that there are no buyers. You are left holding a bag full of dead fish, literally worthless!
Bad bargaining (execution risk) – The entire arbitrage opportunity hinges upon the fact that you can ‘always’ bargain to buy at Rs.100 and sell at Rs.150. What if on a bad day you happen to buy at 110 and sell at 140? You still have to pay 20 for transport, this means instead of the regular 30 Rupees profit you get to make only 10 Rupees, and if this continues, then the arbitrage opportunity would become less attractive and you may not want to do this at all.
1. Transport becomes expensive (cost of transaction) – This is another crucial factor for the profitability of the arbitrage trade. Imagine if the cost of transportation increases from Rs.20 to Rs.30. Clearly, the arbitrage opportunity starts looking less attractive as the cost of execution goes higher and higher. The cost of the transaction is a critical factor that makes or breaks an arbitrage opportunity
2. Competition kicks in (who can drop lower?) – Given that the world is inherently competitive you are likely to attract some competition who would also like to make that risk-free Rs.30. Now imagine this –
  1. So far you are the only one doing this trade i.e buy fish at Rs.100 and sell at Rs.150
  2. Your friend notices you are making a risk-free profit, and he now wants to copy you. You can’t really prevent this as this is a free market.
  3. Both of you buy at Rs.100, transport it at Rs.20, and attempt to sell it in the neighboring town
  4. A potential buyer walks in and sees there is a new seller, selling the same quality of fish. Who between the two of you is likely to sell the fish to the buyer?
  5. Clearly given the fish is of the same quality the buyer will buy it from the one selling the fish at a cheaper rate. Assume you want to acquire the client, and therefore drop the price to Rs.145/-
  6. The next day your friend also drops the price and offers to sell fish at Rs.140 per KG, therefore igniting a price war. In the whole process, the price keeps dropping and the arbitrage opportunity just evaporates.
  7. How low can the price drop? Obviously, it can drop to Rs.120 (cost of buying fish plus transport). Beyond 120, it does not makes sense to run the business
  8. Eventually, in a perfectly competitive world, competition kicks in and arbitrage opportunity just ceases to exist. In this case, the cost of fish in neighboring towns would drop to Rs.120 or a price point in that vicinity.
I hope the above discussion gave you a quick overview of arbitrage. In fact, we can define any arbitrage opportunity in terms of a simple mathematical expression, for example with respect to the fish example, here is the mathematical equation –

The cost of purchasing fish in town A minus the price of selling fish in town B equals 20.

We essentially have an arbitrage opportunity if there is an imbalance in the equation above. There are arbitrage opportunities in all kinds of markets, including the fish market, the agricultural market, the currency market, and the stock market, and they are all governed by straightforward mathematical equations.

6.4 – The Options arbitrage

There are arbitrage opportunities in almost every market, but to find them and profit from them, one must be a keen observer of the market. Typically, stock market-based arbitrage opportunities let you carry a profit regardless of the market’s direction while locking in a small but guaranteed profit. Due to this, risk-averse traders tend to favor arbitrage trades quite a bit.

Here, I’d like to talk about a straightforward arbitrage scenario that has its roots in the idea of “Put-Call Parity.” Instead of going over the Put-Call Parity theory, I’ll quickly describe one of its applications.

However, to better understand the Put Call Parity, I highly recommend watching this stunning video from Khan Academy.

Interesting, huh? But you might wonder, what’s the catch?

Fees for transactions!

To determine if it still makes sense to execute this trade, one must take into account the execution costs. Think about this:

Brokerage fees, which are assessed on a percentage basis when using a traditional broker, will take a bite out of your gains. As a result, while you initially make 10 points, you might also end up paying 8 to 10 points in brokerage. Your breakeven point on this trade, however, would be roughly 4-5 points if you were to execute it with a discount broker like Zerodha. You now have even more justification to sign up for a Zerodha account.
STT: Keep in mind that the P&L is realized. as a result, you would have to hold your positions until expiration. If you are long an ITM option, which you will be, you will have to pay a sizable STT at expiration. This will further reduce your profits. Please read on to learn more.
Additional taxes that may apply include service tax, stamp duty, and others.
Therefore, it might not be worthwhile to carry an arbitrage trade for 10 points given these expenses. But it would undoubtedly do so if the reward was higher—say, 15 or 20 points. By squaring off the positions just before expiration with 15 or 20 points, you can even escape the STT trap, though it will take a little time.

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Bear call ladder

September 29, 2022July 27, 2022 by Rohansharma

Background of Bear Call ladder

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ratio Back Spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ratio back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

4.1 – Background of Bear Call ladder

You shouldn’t be misled into thinking that the “Bear” in “Bear Call Ladder” refers to a bearish strategy. Since the Bear Call Ladder is a variation on the Call ratio back spread, you should use it only if you are unabashedly bullish on the stock or index.

In fact, In a Bear Call Ladder, selling an “in the money” call option covers the cost of buying call options. Additionally, the Bear Call Ladder is typically configured for a “net credit,” where the cash flow is always superior to the cash flow of the call ratio back spread. But keep in mind that while both of these strategies exhibit comparable payoff structures, their risk structures differ just a little.

4.2 – Strategy Notes

The Bear Call Ladder is a 3 leg option strategy, usually setup for a “net credit”, and it involves –

Selling 1 ITM call option
Buying 1 ATM call option
Buying 1 OTM call

This setup, which uses a 1:1:1 ratio, is known as the Bear Call Ladder. The bear Call Ladder must be executed in a ratio of 1:1:1, meaning that for each ITM Call Option sold, an ATM Call Option and an OTM Call Option must be purchased. Other combinations, such as 2:2:2 or 3:3:3, are possible.

Let’s use an example where the Nifty Spot is at 7790 and you predict it will reach 8100 by expiration. This is unmistakably a market bullish outlook. To put the Bear Call Ladder into practice:

Sell 1 ITM Call option
Buy 1 ATM Call option
Buy 1 OTM Call option

Ensure that
The Call options have the same expiration date.
has the same underlying foundation.
The ratio stays the same.

The trade setup is as follows:

The premium received for this 7600 CE, one lot short, is Rs. 247.
The premium for this option is Rs. 117 for 7800 CE, one lot long.
The premium for this option is Rs. 70/- for 7900 CE, one lot long.
247 – 117 – 70 = 60 would be the net credit.

The bear call ladder is executed using these trades. Let’s examine what would happen to the strategies’ overall cash flow at various levels of expiry.

Please keep in mind that because the strategy payoff is quite flexible, we need to assess it at different levels of expiry.

Scenario 1 – Market expires at 7600 (below the lower strike price)

We know the intrinsic value of a call option (upon expiry) is –

Max [Spot – Strike, 0]

The 7600 would have an intrinsic value of

Max [7600 – 7600, 0]

= 0

Due to the fact that we sold this option, we are able to keep the premium received, which is Rs. 247.

The intrinsic value of the 7800 CE and 7900 CE would both be zero, so we would forfeit the premium payments of Rs. 117 and Rs. 70, respectively, that were made.

Net cash flow would be superior. Paid a premium and received

= 247 – 117 – 70

= 60

The market expires at 7660 in Scenario 2 (lower strike plus received net premium).

The 7600 CE would be worth – on an intrinsic level.

Spot – Strike Max [0]

The 7600’s intrinsic worth would be

Max [7660 – 7600, 0]

= 60

We will subtract 60 from 247 due to the 7600 CE’s shortness, keeping the balance.

= 247 – 60

= 187

The value of the 7800 and 7900 CE would expire, so we would forfeit the premiums paid—117 and 70, respectively.

The full strategic benefit would be:

= 187 – 117 – 70

= 0\

The Put Ratio Back Spread is used in these trades. Let’s examine what would happen to the strategies’ overall cash flow at various levels of expiry.

5.3 – Strategy Generalization

Based on the scenarios discussed above, we can draw a few conclusions:

In my opinion, when the quarterly results are due, it is best to use stocks (rather than an index) to implement this strategy.

5.4 – Effect of Greeks

Firstly, Greeks have a similar impact on this strategy as they do on Call Ratio Back spread, particularly in terms of volatility. I’ve copied the discussion on volatility from the previous chapter for your convenience.

undoubtedly, Three colored lines show the relationship between the change in “net premium,” or the strategy payoff, and the change in volatility. These lines give us insight into how an increase in volatility affects the strategy while keeping the time until expiration in perspective.

Blue Line: According to this line, the Bear Call Ladder spread benefits from higher volatility when there are still 30 days until expiration. As we can see, when volatility rises from 15% to 30%, the strategy’s payoff increases from -67 to +43. This obviously implies that when there is enough time before expiration, in addition to being accurate about the direction of the stock or index, you also need to have a view of volatility. Due to this, even though I’m optimistic about the stock, I

would be hesitant to use this strategy at the beginning of the series if volatility is higher than average (say more than double of the usual volatility reading)

Green line – This line suggests that, although not as much as in the preceding case, an increase in volatility is advantageous when there are roughly 15 days until expiration. As we can see, when volatility rises from 15% to 30%, the strategy payoff increases from -77 to -47.

Red line: This result is intriguing and illogical. The strategy is negatively impacted by an increase in volatility when there are only a few days left until expiration! Consider the possibility that a rise in volatility when there are few days left before expiration

As a result of the option’s OTM expiration, the premium drops. So, if you are bullish on a stock or index with a few days left until expiration and you anticipate that volatility will rise during this time, proceed with caution.

Clearly, The best strikes to choose are deep ITM and slightly ITM, i.e., 7600 (lower strike short) and 7900, if you expect the move during the second half of the series and you expect it to happen within a day (or within 5 days, graph 2). (higher strike long). Please take note that this is an ITM and ITM spread rather than the traditional combination of an ITM + OTM spread. In actuality, none of the other combinations work.

Please keep in mind that because the strategy payoff is quite flexible, we need to assess it at different levels of expiry.

At last, The blue line indicates that a rise in volatility with plenty of time left before expiration (30 days) is advantageous for the put ratio back spread. As we can see, when volatility rises from 15% to 30%, the strategy payoff increases from -57 to +10. This obviously implies that when there is enough time before expiration, in addition to being accurate about the direction of the stock or index, you also need to have a view of volatility. Because of this, even though I am bearish on the stock, I might be hesitant to use this strategy at the beginning of the series if volatility is higher than average (say more than double the usual volatility reading)

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Call ratio Back spread

September 27, 2022July 26, 2022 by Rohansharma

Call ratio Back spread

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ratio Back Spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

4.1 – Background of call ratio back spread

A fascinating options strategy is the Call Ratio Back Spread. Considering how easy it is to implement and the kind of payoff it offers the trader, I consider this to be interesting. This should undoubtedly be included in your toolbox of tactics. In contrast to bull call spreads and bull put spreads, which are used when one is only mildly bullish on a stock (or index), this strategy is used when one is outright bullish on it.

When using the Call Ratio Back Spread, you will primarily experience the following:

Unlimited profit if the market goes up
Limited profit if market goes down
A predefined loss if the market stay within a range

In simpler words you can get to make money as long as the market moves in either direction.

The Call Ratio Back Spread is typically used for a “net credit,” which means that money starts to arrive in your account as soon as you execute the strategy. In contrast to what you anticipated, the “net credit” is what you earn if the market declines (i.e market going up). On the other hand, if the market does increase, you could stand to gain an endless amount of money. This should also clarify why purchasing a call ratio spread rather than a standard call option is preferable.

So let’s investigate how this operates right away.

4.2 – Strategy Notes

As it involves purchasing two OTM call options and selling one ITM call option, the Call Ratio Back Spread is a three-legged option strategy. This is the standard 2:1 combination. The call ratio back spread must actually be executed in a 2:1 ratio, which means that two options must be purchased for everyone option sold, four must be purchased for every two options sold, and so on.

Let’s use an example where the Nifty Spot is at 7743 and you predict it will reach 8100 by expiration. This is unmistakably a market bullish outlook. In order to use the Call Ratio Back Spread:

Sell one lot of 7600 CE (ITM)
Buy two lots of 7800 CE (OTM)

Make sure –

The Call options belong to the same expiry
Belongs to the same underlying
The ratio is maintained

The trade set up looks like this –

7600 CE, one lot short, the premium received for this is Rs.201/-
7800 CE, two lots long, the premium paid is Rs.78/- per lot, so Rs.156/- for 2 lots
Net Cash flow is = Premium Received – Premium Paid i.e 201 – 156 = 45 (Net Credit)

The call ratio back spread is used in these trades. Let’s examine what would happen to the strategies’ overall cash flow at various levels of expiry.

Please keep in mind that because the strategy payoff is quite flexible, we need to assess it at different levels of expiry.

The market expires in scenario 1 at 7400. (below the lower strike price)

We are aware that a call option’s intrinsic value (upon expiration) is:

Spot – Strike Max [0]

The 7600’s intrinsic worth would be

Max [7400 – 7600, 0]

= 0

Given that we sold this option, we are entitled to keep the premium received, which is Rs. 201.

Since the intrinsic value of the 7800 call option would also be zero, we would forfeit the entire premium, which works out to 78 rupees per lot or 156 rupees for two lots.

Net cash flow would be superior. Paid a premium and received

= 201 – 156

= 45

Scenario 2 – Market expires at 7600 (at the lower strike price)

Both of the call options, 7600 and 7800, would have zero intrinsic value and would therefore expire worthless.

The premium, which amounts to Rs. 201 for the 7600 CE, is ours to keep; however, we forfeit Rs. 156 for the 7800 CE, leaving us with a net reward of Rs. 45.

Situation 3: The market closes at 7645 (at the lower strike price plus net credit)

If you’re wondering why I chose the level of 7645, it’s because this is where the strategy break even is.

7600 CE’s intrinsic value would be:

Spot – Strike Max [0]

= [7645 – 7600, 0]

= 45

Since we sold this option for 201, the option’s net profit would be

201 – 45

On the other hand, we spent an additional 156 to purchase two 7800 CE. We lose the entire premium because it is obvious that the 7800 CE will expire worthless.

The net payoff is:

156 – 156

= 0

Scenario 3 – Market expires at 7700 (half way between the lower and higher strike price)

The 7600 CE would be intrinsically worth 100, while the 7800 would be worthless.

On the 7600 CE, we keep 101 instead of losing 100 from the 201 premium we received, which is 201 – 100 = 101.

The entire Rs. 156 premium on the 7800 CE is lost, so the strategy yields a total payoff of

= 101 – 156

= – 55

Scenario 4 – Market expires at 8100 (higher than the higher strike price, your expected target)

The intrinsic values of the 7600 CE and 7800 CE will be 500 and 300 respectively.

The final result would be:

Premium Paid for 7800 CE – Premium Received for 7600 CE – Intrinsic Value of 7600 CE + (2* Intrinsic Value of 7800 CE)

= 201 – 500 + (2*300) – 156

= 201 – 500 + 600 -156

= 145

Here are some additional levels of expiration and the strategy’s ultimate reward. Keep in mind that as the market rises, so do the profits, but when the market falls, you still make some money, albeit a small amount.

4.3 – Strategy Generalization

Going by the above discussed scenarios we can make few generalizations –

Spread = Higher Strike – Lower Strike
Net Credit = Premium Received for lower strike – 2*Premium of higher strike
Max Loss = Spread – Net Credit
Max Loss occurs at = Higher Strike
The payoff when market goes down = Net Credit
Lower Breakeven = Lower Strike + Net Credit
Upper Breakeven = Higher Strike + Max Loss

Here is a graph that highlights all these important points –

4.4 – Welcome back the Greeks

Before understanding the graphs above, note the following –

Nifty spot is assumed to be at 8000
Start of the series is defined as anytime during the first 15 days of the series
End of the series is defined as anytime during the last 15 days of the series
The Call Ratio Back Spread is optimized and the spread is created with 300 points difference

The market is predicted to increase by about 6.25 percent, or from 8000 to 8500. In light of the move and the remaining time, the graphs above indicate that –

Top left on Graph 1 and top right on Graph 2 – The most profitable strategy is a call ratio spread using 7800 CE (ITM) and 8100 CE (OTM), where you would sell 7800 CE and buy 2 8100 CE. This is because you are at the beginning of the expiry series and you anticipate the move over the next 5 days (and 15 days in the case of Graph 2) Do keep in mind that even though you would be correct about the movement’s direction, choosing other far OTM strikes call options usually results in losses.

Graphs 3 and 4 (bottom left and bottom right, respectively) – A Call Ratio Spread using 7800 CE (ITM) and 8100 CE (OTM) is the most profitable option if you are at the beginning of the expiry series and anticipate the move in 25 days (and expiry day in the case of Graph 3). In this scenario, you would sell 7800 CE and buy 2 8100 CE.
You must be wondering why the number of strikes is the same regardless of the time remaining. In fact, this is the key: the call ratio back spread functions best when you sell slightly ITM options and buy slightly OTM options with plenty of time left before expiration. In actuality, all other combinations are in the red, particularly those that include far OTM options.

Three colored lines show the relationship between the change in “net premium,” or the strategy payoff, and the change in volatility. These lines give us insight into how an increase in volatility affects the strategy while keeping the time until expiration in perspective.

The blue line indicates that a rise in volatility with plenty of time left before expiration (30 days) is advantageous for the call ratio back spread. As we can see, when volatility rises from 15% to 30%, the strategy’s payoff increases from -67 to +43. This obviously implies that when there is enough time before expiration, in addition to being accurate about the direction of the stock or index, you also need to have a view of volatility. Because of this, even though I believe the stock will rise, I would be a little hesitant to use this strategy at the beginning of the series if volatility is higher than average (say more than double the usual volatility reading)

Green line – This line suggests that, although not as much as in the preceding case, an increase in volatility is advantageous when there are roughly 15 days until expiration. As we can see, when volatility rises from 15% to 30%, the strategy payoff increases from -77 to -47.

Red line: This result is intriguing and illogical. The strategy is negatively impacted by an increase in volatility when there are only a few days left until expiration! Consider that a rise in volatility near the expiration date increases the likelihood that the option will expire in the money, which lowers the premium. So, if you are bullish on a stock or index with a few days left until expiration and you anticipate that volatility will rise during this time, proceed with caution.

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Bull Put Spread

September 29, 2022July 26, 2022 by Rohansharma

3.1 – Why Bull Put Spread?

Basics of stock market

• Introduction
• Bull call spread
• Bull put spread
• Call ration Back Spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

3.1 – Introduction - Why Bull Put Spread?

First of all The Bull Put Spread, which has two legs like the Bull Call Spread, is used when the market outlook is “moderately bullish.” In terms of payoff structure, the Bull Put Spread is comparable to the Bull Call Spread, but there are some differences in terms of strategy execution and strike choice. The bull put spread involves using put options rather than call options to create a spread (as is the case in bull call spread).

At this point, you might be asking yourself why one should choose one strategy over another when the payoffs from both a bull call spread and a bull put spread are comparable.

Well, this really depends on how attractive the premiums are. While the Bull Call spread is executed for debit, the bull put spread is executed for credit. So if you are at a point in the market where –

The markets have declined considerably (therefore PUT premiums have swelled)
The volatility is on the higher side
There is plenty of time to expiry

In fact, If you have a moderately bullish outlook looking ahead, then it makes sense to invoke a Bull Put Spread for a net credit as opposed to invoking a Bull Call Spread for a net debit. Apart from this, Personally, I do prefer strategies that offer net credit rather than strategies that offer net debit.

3.2 – Strategy Notes

Firstly, The bull put spread is a two-leg spread strategy traditionally involving ITM and OTM Put options. However, you can create the spread using other strikes as well.

To implement the bull put spread –

Buy 1 OTM Put option (leg 1)
Sell 1 ITM Put option (leg 2)

When you do this ensure –

All strikes belong to the same underlying
Belong to the same expiry series
Each leg involves the same number of options

For example –

Date – 7^th December 2015

Outlook – Moderately bullish (expect the market to go higher)

Nifty Spot – 7805

Bull Put Spread, trade set up –

Purchase 7700 PE by paying a premium of Rs. 72; keep in mind that this is an OTM option. This is a debit transaction because money is being taken out of my account.

Selling 7900 PE will earn you Rs 163/- in premium; keep in mind that this is an ITM option. This is a credit transaction because I receive money.

Clearly, The difference between the debit and credit, or the net cash flow, is 163 minus 72, or +91. Since this is a positive cash flow, my account has a net credit.

Undoubtedly, A bull put spread is also known as a “Credit spread” because, generally speaking, there is always a “net credit” in them.

Generally, The market may move in any direction and expire at any level after we place the trade. In order to understand what would happen to the bull put spread at various levels of expiry, let’s consider a few scenarios.

Situation 1: The market closes at 7600 (below the lower strike price i.e OTM option)

The intrinsic value of the Put option determines its value at expiration. If you remember from the previous module, a put option’s intrinsic value at expiration is –

The strike-spot Max

The intrinsic value of 7700 PE would be –

Max [7700 – 7600 – 0]

= Max [100, 0]

= 100

By investing a premium of Rs. 72 and becoming long on the 7700 PE, we would make

= Value at Risk – Premium Paid

= 100 – 72

= 28

Similar to the 7900 PE option, which has an intrinsic value of 300 but was sold or written at Rs. 163,

Refund for the 7900 PE In this case,

163 – 300

= – 137

broader strategy

The overall strategy’s results would be:

+ 28 – 137

= – 109

The market expires in scenario 2 at 7,700 (at the lower strike price i.e the OTM option)

Since the 7700 PE won’t have any intrinsic value, we will forfeit the entire premium we paid, or Rs. 72.

The intrinsic value of the 7900 PE will be Rs. 200.

The strategy’s net payoff would be:

Premium from the sale of 7900 PE less the intrinsic value of 7900 PE less the premium for 7700 PE

= 163 – 200 – 72

= – 109

Situation 3: The market closes at 7900 (at the higher strike price, i.e ITM option)

Since both 7700 PE and 7900 PE have zero intrinsic value, both potions would be worthless when they expired.

The strategy’s net payoff would be:

Received premium for 7900 PE

= 163 – 72

= + 91

Situation 4: The market closes at 8000 (above the higher strike price, i.e the ITM option)

In short, The total strategy payoff would be 7700 PE and 7900 PE since both options would expire worthlessly.

The premium for 7900 PE received minus the Premium for 7700 PE paid

= 163 – 72

= + 91

To sum it up:

Importantly, Three things should be obvious to you after reading this analysis:

When the market moves higher, the strategy is profitable.

Otherwise, No matter how much the market declines, the maximum loss is only Rs. 109, which also happens to be the difference between the strategy’s “Spread and net credit.”

There is a 91 percent profit cap. This also happens to be the strategy’s net credit.
The “Spread” can be described as”

3.3 – Other Strike combinations

By the way, Keep in mind that the spread is the difference between the two strike prices. However, the strikes that you select can be any OTM and any ITM strike. The Bull Put Spread is always created with 1 OTM Put and 1 ITM Put option. The spread increases with strike distance, and the potential reward increases with spread size as well.

Consider the following examples while the spot is at 7612:

Lastly, The key takeaway from this is that you can combine any number of OTM and ITM options to create a spread. However, the risk-reward ratio varies depending on the strikes you select (and consequently, the spread you create). In general, go ahead and create a larger spread if you have a strong conviction in your “moderately bullish” view; otherwise, stick to a smaller spread.

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Bull call spread

September 29, 2022July 26, 2022 by Rohansharma

Bull Call Spread

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ration Back spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

2.1 – Background

One of the simplest option strategies a trader can use is the spread strategy. Spreads are multi-legged strategies with at least two options. When I refer to multi-leg strategies, I mean that at least two option transactions are necessary.

The best time to use a spread strategy like the “Bull Call Spread” is when your outlook on the stock or index is “moderate” and not particularly “aggressive.” For instance, the outlook for a specific stock might be described as “moderately bullish” or “moderately bearish.”

The following are some typical circumstances that can cause your outlook to change to “moderately bullish”:

From a fundamental standpoint, Reliance Industries is anticipated to announce its Q3 quarterly results. You are aware that the Q3 results are anticipated to be better than both the Q2 and Q3 of last year based on the management’s Q2 quarterly guidance. You are unsure of exactly by how many basis points the outcomes will be better, though. This is obviously the piece of the puzzle that is missing.

Given this, you anticipate that the stock price will rise after the results are announced. However, the market may have partially taken the news into account because the guidance was provided in Q2. This makes you believe that the stock’s potential upside is constrained.

Technical Perspective – The stock that you are tracking has been in the down trend for a while, so much so that it is at a 52 week low, testing the 200 day moving average, and also near a multi-year support. Given all this there is a high probability that the stock could stage a relief rally. However you are not completely bullish as whatever said and done the stock is still in a downtrend.

Quantitative Perspective – The stock is consistently trading between the 1^st standard deviation both ways (+1 SD & -1 SD), exhibiting a consistent mean reverting behavior. However there has been a sudden decline in the stock price, so much so that the stock price is now at the 2^nd standard deviation. There is no fundamental reason backing the stock price decline, hence there is a good chance that the stock price could revert to mean. This makes you bullish on the stock, but the fact that it there is a chance that it could spend more time near the 2^nd SD before reverting to mean caps your bullish outlook on the stock.

The point is that any theory, whether fundamental, technical, or quantitative, could be used to develop your perspective, and you could end up with a “moderately bullish” outlook. In actuality, this also holds true for a “moderately bearish” outlook. You can easily use a spread strategy in this situation to set up your option positions in a way that

You defend yourself in the negative (in case you are proved wrong)
Additionally, the amount of profit you make is predetermined (capped)
You receive the opportunity to participate in the market for less money as a trade-off (for capping your profits).

2.2 – Strategy notes

The bull call spread is one of the most widely used spread strategies. When you have a moderately bullish outlook for the stock or index, the strategy is useful.

A two-leg spread strategy called the bull call spread typically uses ATM and OTM options. However, you can also use other strikes to make the bull call spread.

To implement the bull call spread –

Buy 1 ATM call option (leg 1)
Sell 1 OTM call option (leg 2)

When you do this ensure –

All strikes belong to the same underlying
Belong to the same expiry series
Each leg involves the same number of options

For example –

Date – 23^rd November 2015

Outlook – Moderately bullish (expect the market to go higher but the expiry around the corner could limit the upside)

Nifty Spot – 7846

ATM – 7800 CE, premium – Rs.79/-

OTM – 7900 CE, premium – Rs.25/-

Bull Call Spread, trade set up –

Buy 7800 CE by paying 79 towards the premium. Since money is going out of my account this is a debit transaction
Sell 7900 CE and receive 25 as premium. Since I receive money, this is a credit transaction
The net cash flow is the difference between the debit and credit i.e 79 – 25 = 54.

Generally speaking in a bull call spread there is always a ‘net debit’, hence the bull call spread is also called referred to as a ‘debit bull spread’.

After we initiate the trade, the market can move in any direction and expiry at any level. Therefore let us take up a few scenarios to get a sense of what would happen to the bull call spread for different levels of expiry.

Scenario 1 – Market expires at 7700 (below the lower strike price i.e ATM option)

The value of the call options would depend upon its intrinsic value. If you recall from the previous module, the intrinsic value of a call option upon expiry is –

Max [0, Spot-Strike]

In the case of 7800 CE, the intrinsic value would be –

Max [0, 7700 – 7800]

= Max [0, -100]

= 0

Since the 7800 (ATM) call option has 0 intrinsic value we would lose the entire premium paid i.e Rs.79/-

The 7900 CE option also has 0 intrinsic value, but since we have sold/written this option we get to retain the premium of Rs.25.

So our net payoff from this would be –

-79 + 25

= 54

Do note, this is also the net debit of the overall strategy.

2.3 – Strike Selection

How would you rate the moderate bullishness or bearishness? Would a move of 5% on the Infosys stock qualify as moderately bullish, or should it be a move of 10% or more? What about the Nifty 50 and Bank Nifty indices? What about stocks with mid-caps like Yes Bank, Mindtree, Strides Arcolab, etc.? There is obviously no one size fits all answer to this problem. By analysing the stock/index volatility, one can try to quantify the move’s “moderate-ness.”

I have developed a few rules based on volatility; they seem to work for me, but you might want to improvise further. If the stock is highly volatile, I would classify a move of 5-8 percent as “moderate.” However, I might think about going under 5% if the stock is not very volatile.

What strikes should you choose for the bull call spread given that you have a “moderately bullish” view on the Nifty 50 (sub 5% move)? Is the ATM + OTM combination the ideal spread?

Theta, oh faithful Theta, holds the key to the solution!

You can use the following collection of graphs to determine the best possible strikes based on the remaining time.

The best strikes to choose are far OTM, i.e., 8600 (lower strike long) and 8900, if you expect a moderate move during the second half of the series and you expect the move to happen within a day (or two) (higher strike short).

The best strikes to choose are far OTM, i.e., 8600 (lower strike long) and 8900, if you anticipate a moderate move during the second half of the series and you anticipate the move to occur over the next 5 days (higher strike short). Be aware that while Graphs 1 and 2 both suggest the same strikes, the profitability of the strategy decreases due to Theta’s effect.

The best strikes to choose are slightly OTM in Graph 3 (bottom right), if you anticipate a moderate move during the second half of the series and that it will occur over the next 10 days (1 strike away from ATM)

Graph 4 (bottom left) – The best strikes to choose are ATM, i.e., 8000 (lower strike, long) and 8300, if you anticipate a moderate move during the second half of the series and you anticipate the move to occur on expiry day (higher strike, short). Keep in mind that even if the market rises, far OTM options lose money.

2.4 – Creating Spreads

Here is something you should be aware of: the higher the potential profit is, the wider the spread, but as a trade-off, the breakeven point also rises.

For instance:

The first day of the December series is today, November 28. Nifty is currently trading at 7883; consider these 3 bull call spreads.

The key takeaway is that the risk-reward ratio varies according to the strikes you select. However, don’t let the risk-reward ratio solely determine the strikes you take. Be aware that you can create a bull call spread with just two options, for instance, by buying two ATM and selling two OTM.

Do take the Greeks into account when trading options, and Theta in particular!

I suppose the foundation for understanding fundamental “spreads” has been laid in this chapter. I’ll assume going forward that you are aware of what a moderately bullish or bearish move would entail, so I’ll probably start with the strategy notes.

For visit: Click here to know the directions.

Introduction

September 27, 2022July 26, 2022 by Rohansharma

Introduction

Basics of stock market

• Induction
• Bull call spread
• Bull put spread
• Call ration Back spread
• Bear call ladder
• Synthetic long & Arbitrage
• Bear put spread

• Bear call spread
• put ration back spread
• Long straddle
• Short straddle
• Max pain & PCR ratio
• Iron condor

1.1 Induction

Before we begin this module on options strategy, I would like to share with you an article I read in behavioral finance a few years ago. The title of the article was “Why winning is addictive.”

Here is the article written by B. Venkatesh, a consistent columnist for HBL:

To purchase and wager on a lottery ticket, a game you usually steer clear of because you know the chances of winning the jackpot are slim. If you do, however, win the ticket, you’ll probably feel pressured to continue purchasing lottery tickets in the future!

We behave similarly in terms of our investments as well. Why does this behavior occur? Our lives as humans are governed by anticipation. So both the anticipation of and fulfillment of a lottery win are exciting.

But according to neuroscience studies, dreaming about winning is more thrilling than actually succeeding! However, after experiencing the thrill of winning the lottery, you feel compelled to overeat. In other words, even though you know the odds of winning the second lottery ticket, your brain forces you to buy the first one.

The fact that we can lose money makes our experience of winning against such odds even more exciting! This is not so much true of lottery because a lottery is a game of chance while investments, we believe, require some degree of skill”

You might be wondering why I posted the aforementioned article at the start of this module. This article, however, takes some of my ideas a step further by putting them in the context of behavioral finance. One thing that I’ve noticed in all the conversations I’ve had with options traders, both seasoned and new, is that most of them view trading options as a hit-or-miss proposition. When one begins an options trade, there is always a sense of humor; however, many people are unaware of how fatal this naive humor can be.

Traders buy options (month after month) with the hope they would double their investment. Trading options with such a mindset is a perfect recipe for a P&L disaster. The bottom line is this – if you aspire to trade options, you need to do it the right way and follow the right approach. Else you can rest assured the gambling attitude will eventually consume your entire trading capital and you will end up having a short, self-destructive option trading career.

I do have to point out that the saying “limited risk, unlimited profit potential” is a silent P&L killer when it comes to options. This “theoretically correct” but practically disastrous fact disillusions new traders, who then slowly and steadily blow up their books as a result. As a result, in my opinion, trading options without a plan is a “dangerous but irresistible past time” (a quote from Pink Floyd).

1.2 – What should you know?

Only a small number of strategies must be thoroughly understood by you. Knowing these strategies makes it simple to map the current market (or stock) situation with the appropriate option strategy from your strategy quiver.

We will discuss some tactics while keeping this in mind.

Besides discussing the above strategies I also intend to discuss –

Max Pain for option writing – (some key observations and practical aspects)
Volatility Arbitrage employing Dynamic Delta hedging

One options strategy will be covered in each chapter so that there is no muddle or confusion regarding the strategy. This means that this module will consist of roughly 20 chapters, though I suppose that each chapter won’t be overly long. I’ll go over each strategy’s history, execution, payoff, breakeven point, and perhaps the best strikes to make given the remaining time. If you want to use the strategy, I’ll also be sharing a working Excel model with you.

Please keep in mind that while I will discuss all of these strategies using the Nifty Index as a benchmark, you can apply the same principles to any stock option.

The most crucial thing I want you to know is that this module will not contain the Holy Grail. Nothing in the markets, including none of the strategies we discuss in this module, is a guaranteed way to make money. The goal of this module is to ensure that we discuss a few straightforward but crucial tactics that, when used properly, can generate income.

Consider it this way: if you drive your car safely and well, you can use it to commute and ensure your family’s comfort. However, if you drive rashly, it could be dangerous for both you and those around you.

Similar to how these strategies generate income when used properly if not, they can damage your P&L. It is my responsibility to make sure you comprehend these techniques so you can learn how to drive a car. I will also try to explain the ideal circumstances in which you should apply these techniques. But you have the power to make it work for you; this really depends on your discipline and market savvy. Having said that, I have a good feeling that as you spend more ‘quality’ time in the markets, your application of strategies will get better.

The “Bull Call Spread” makes its debut in the next chapter, which focuses on bullish strategies.

Remain tuned.

Rights, ofs,fpo and more

September 27, 2022July 25, 2022 by Rohansharma

• Rights, ofs,fpo and more

Basics of stock market

• Why invest?
• who regulates
• financial interdependence
• IPOs
• Stock Market returns
• Trading system

• Day end settlements
• Corporate actions
• News and Events
• Getting started
• Rights, ofs,fpo and more
• Notes

IPO, OFS, and FPO – How are they different?

Firstly, A company is first introduced to the publicly traded stock markets through an initial public offering. The promoters of the business decision to sell a specific number of shares to the general public during the IPO. Chapters 4 and 5 provide a thorough explanation of the rationale for going public as well as the IPO procedure.

Secondly, Going public is primarily done to raise money for expansion projects or to pay out early investors. The company’s promoters might still require additional funding after the IPO. They are listed on the exchange and traded in the secondary market. There are three possibilities: Rights Issue, Offer for Sale, and Public Offer Subsequent.

The Broker of Stock

Importantly, The promoters have the option to solicit additional. By funding from their current investors. They provide them with new shares at a reduced price.

In proportion to the existing shares held by shareholders, the company issues new shares. For instance, a 1:4 rights issue would offer 1 additional share for every 4 shares already held.

This option may seem appealing, but it restricts the company from raising money from a select group of shareholders. Who may not want to make additional investments?

Since, When shares are created and offered to shareholders as part of a rights issue, the value of the previously held shares is diminished.

OFS

Undoubtedly, The promoters can choose to offer the secondary issue of shares to the whole market. Unlike a rights issue restricted to existing shareholders. Moreover, The Exchange provides a separate window through the stockbrokers for the Offer for Sale.

The exchange allows a company to route funds through OFS only if the Promoters want to sell out their holdings. Maintain minimum public shareholding requirements (Govt. PSU has a public shareholding requirement of 25%).

Also, there is a floor price set by the company, at or above which both Retail and Non-Retail investors can make bids. The shares are allotted, and if bids are at a cut-off price or above will be settled by the exchange into the investor Demat account in T+1 days.

For example, an Offer for Sale is NTPC limited. Which offered a maximum of 46.35 million shares at a floor price of Rs 168 and was fully subscribed in the 2-day period. The OFS was held on 29th August 2017 for Non-Retail Investors and 30th August 2017.

FPO

Definitely, The goal of an FPO is to raise additional capital after it has been listed, but it uses a different application and shares allocation process. Without a doubt, An FPO allows for the creation of new shares as well as the diluting of existing ones. Similar to an IPO, an FPO requires the appointment of Merchant Bankers to draught a Draft Red Herring. Furthermore, The prospectus that must then be approved by SEBI before bidding can begin within a three to five-day window.

Shares are allocated based on the Cut-off Price decided after the book-building process. Investors can place their bids through ASBA. At last, FPOs are rarely used now that OFS has been available since 2012 because of the drawn-out approval process.

Accordingly, The FPO is made public knowledge after the company selects a Price Band. Interested parties can apply offline at a bank branch or online through the ASBA portal using Internet Banking. Especially, Following the close of the bidding, the demand-based cut-off price is announced. The additional shares awarded are listed on the exchange for trading in the secondary markets.

Certainly, Engineers India Ltd. underwent an issue in February 2014 with a price range of Rs. 145–Rs. 150, is an example of an FPO. There was a threefold oversubscription for the issue. The shares were trading at Rs 151.1 on the day the issue officially began. The lower price band was 4.2% less expensive than the going rate.

Difference between OFS and FPO

An OFS is used to offload Promoters’ shares while an FPO is used to fund new projects.
Dilution of shares is allowed in an FPO leading to change in the Shareholding structure. While OFS does not affect the number of authorized shares.
Only the top 200 companies by Market Capitalisation can use the OFS route to raise funds while all listed companies can use the FPO option.
Ever since SEBI introduced OFS, FPO issues have come down, and companies prefer to choose the OFS route to raise funds

Basics of stock market

4.1 – Background of Bear call ladder

4.2 – Strategy Notes

5.3 – Strategy Generalization

5.4 – Effect of Greeks

Bear Call Spread

Basics of stock market

8.1 – Choosing Calls over Puts

Strategy Notes

8.2 – Strategy Notes 2.0

8.3 – Strategy Generalization

8.4 – Strike Selection and impact of Volatility

Basics of stock market

7.1 – Spreads versus naked positions

4.2 – Strategy Notes

The Bear Put Spread is similarly simple to use as the Bull Call Spread. When the market outlook is moderately bearish,

that is, when you anticipate that the market will decline in the short term but not significantly, you would use a bear put spread. A correction of 4-5 percent would be appropriate if I were to quantify what “moderately bearish” means.

If the markets are correct as anticipated (go down), one would make a modest profit by using a bear put spread; however,

if the markets go up, the trader would only suffer a small loss.

A conservative trader (read as a risk-averse trader) would implement the Bear Put Spread strategy by simultaneously –

Buying an In the money Put option

Selling an Out of the Money Put option

Nifty is currently trading at 7485, which means that 7600 PE is in the black and 7400 PE is out of the money.

To use the “Bear Put Spread,” one would have to sell the 7400 PE, and the premium they would receive from doing so would help to pay for the 7600 PE.

In relation to the 7600 PE, the premium received (PR) is Rs. 73, and the premium paid (PP) is Rs. 165.

This transaction’s net debit would be –

We need to take into account various scenarios in order to comprehend how the strategy’s payoff functions under various expiry conditions. Please keep in mind that the payoff occurs at expiration, which means that the trader must hold these positions until expiration.

Situation 1: The market closes at 7800 (above long put option i.e 7600)

In this instance, the market has increased despite expectations that it would decline. Both of the put options at 7800, 7600, and 7400, would have no intrinsic value and would therefore expire worthlessly.

Please take note that the ‘-ve’ sign next to 165 denotes a money outflow from the account, while the ‘+ve’ sign next to 73 denotes a money inflow into the account.

Additionally, the strategy’s net debit is equal to the strategy’s net loss of 92.

Scenario 2 – Market expired at 7600 (at long put option)

Here, we’ll assume that the market expires at 7600, the price at which we bought the Put option.

Then, at 7600, both the PE for 7600 and the PE for 7400 would expire worthless (similar to scenario 1),

resulting in a loss of -92.

Scenario 3 – Market expires at 7508 (breakeven)

7508 is halfway through 7600 and 7400, and as you may have guessed I’ve picked 7508 specifically to showcase that the strategy neither makes money nor loses any money at this specific point.

The 7600 PE would have an intrinsic value equivalent to Max [7600 -7508, 0], which is 92.

Since we have paid Rs.165 as a premium for the 7600 PE, some of the premium paid would be recovered. That would be 165 – 92 = 73, which means to say the net loss on 7600 PE at this stage would be Rs.73 and not Rs.165

The 7400 PE would expire worthlessly, hence we get to retain the entire premium of Rs.73

So on hand, we make 73 (7400 PE) and on the other, we lose 73 (7600 PE) resulting in a no loss no profit situation

Hence, 7508 would be the breakeven point for this strategy.

Scenario 4 – Market expires at 7400 (at short put option)

This is an interesting level, do recall when we initiated the position the spot was at 7485, and now the market has gone down as expected. At this point, both options would have interesting outcomes.

The 7600 PE would have an intrinsic value equivalent to Max [7600 -7400, 0], which is 200

We have paid a premium of Rs.165, which would be recovered from the intrinsic value of Rs.200, hence after compensating for the premium paid one would retain Rs.35/-

The 7400 PE would expire worthlessly, hence the entire premium of Rs.73 would be retained

The net profit at this level would be 35+73 = 108

The net payoff from the strategy is in line with the overall expectation from the strategy i.e the trader gets to make a modest profit when the market goes down.

Situation 5: The market closes at 7200 (below the short put option)

Again, this is an intriguing level because both possibilities would be valuable in and of themselves.

Let’s determine whether the numbers add up.

The intrinsic value of the 7600 PE would be equal to Max [7600 -7200, 0], which is 400.After paying back the premium of Rs. 165 that we paid, which would be recovered from the intrinsic value of Rs. 400,

one would still be left with Rs. 235.The intrinsic value of the 7400 PE would be Max [7400 -7200, 0], which is 200.We were given a premium of Rs. 73, but we will have to forfeit it and take a loss in excess of Rs. This equals 200 – 73.

7.3 – Strategy critical levels

7.4 – Quick note on Delta

7.5 – Strike selection and effect of volatility

4.3 – Strategy Generalization

4.4 – Welcome back the Greeks

Before understanding the graphs above, note the following –

The nifty spot is assumed to be at 8000

The start of the series is defined as any time during the first 15 days of the series

The end of the series is defined as any time during the last 15 days of the series

The Call Ratio Back Spread is optimized and the spread is created with 300 points difference

The market is predicted to increase by about 6.25 percent, or from 8000 to 8500. In light of the move and the remaining time, the graphs above indicate that –

Three colored lines show the relationship between the change in “net premium,” or the strategy payoff, and the change in volatility. These lines give us insight into how an increase in volatility affects the strategy while keeping the time until expiration in perspective.

The blue line indicates that a rise in volatility with plenty of time left before expiration (30 days) is advantageous for the

Green line – This line suggests that, although not as much as in the preceding case, an increase in volatility is advantageous when there are roughly 15 days until expiration. As we can see, when volatility rises from 15% to 30%, the strategy payoff increases from -77 to -47.

Basics of stock market

6.1 – Background

4.2 – Strategy Notes

6.3 – The Fish market Arbitrage

6.3 – The Fish market Arbitrage

6.4 – The Options arbitrage

Basics of stock market

4.1 – Background of Bear Call ladder

4.2 – Strategy Notes

The Bear Call Ladder is a 3 leg option strategy, usually setup for a “net credit”, and it involves –

Selling 1 ITM call option

Buying 1 ATM call option

The intrinsic value of the 7600 PE would be equal to Max [7600 -7200, 0], which is 400.
After paying back the premium of Rs. 165 that we paid, which would be recovered from the intrinsic value of Rs. 400,

one would still be left with Rs. 235.
The intrinsic value of the 7400 PE would be Max [7400 -7200, 0], which is 200.
We were given a premium of Rs. 73, but we will have to forfeit it and take a loss in excess of Rs. This equals 200 – 73.

The Call options have the same expiration date.
has the same underlying foundation.
The ratio stays the same.

The premium received for this 7600 CE, one lot short, is Rs. 247.
The premium for this option is Rs. 117 for 7800 CE, one lot long.
The premium for this option is Rs. 70/- for 7900 CE, one lot long.
247 – 117 – 70 = 60 would be the net credit.