Long Term Options | Stocks and Commodities

August 27, 2013
Time: 9.30 pm

Introduction:

Markets may go up and down and may be very volatile in the short term. So trading in stock market becomes very difficult. In this scenario, long term options will be a good idea to make money.

The strategy:

Sell Dec 2014 expiry 4000 Put option one lot and 8000 Call option one lot.

Mathematics behind the strategy:

4000 Put option closed at Rs 131 and 8000 Call option closed at Rs 65.
By selling one lot each we will  collect a total premium of 9800 (50*(131+65)).
Span margin required for this trade is Rs 20000. Keeping about Rs 5000 for MTM losses in case if the market continue to move violently, the total investment is Rs 25000. The return works out to be approximately 40% for a period of 16 months. So annualised return is about 30%. Considering the volatility and uncertainty, 30% annualised return is very good.

Rationale behind the strategy:

Market has not fallen below 4500 in the last 4 years. There is a very strong support at 4500 in the long term. Moreover, unlike 2008 and 2011, this time the fall in the market is largely due to local factors like currency depreciation, political uncertainties, policy paralysis, twin deficits, etc. So even over the next 16 months period, market is not likely to fall below 4500.

On the other hand, even during the secular bull run, the index has not given 50% return in 15-16 months. From the current levels, 8000 is about 50% higher. So the market is not likely to go to 8000 by Dec 2014.
There will be huge selling between 6400 and 7000. In fact market will find it very difficult to move beyond 7000.

Fine tuning the strategy:

We will have to review this strategy periodically. The index may not go below 4000 or above 8000, but it can always move towards one of these targets. This position should be held as long as the index is trading between 4800 and 6400. If the index moves beyond this range, we will be required to cut the positions and open new position. It also depends on when this range is broken. 

We will review this strategy once in a month.