How the #Brexit trade returned 5% in 5 days


Uncle Theta - Options - Is there a #Brexit Play - Capitalmind | Active Investing

Uncle Theta doesn’t like to boast. But what to do if things just worked well, and Uncle had to tell you how? So let me. 
Remember the #Brexit play we described last week? It has made a 5%+ return since. Let’s walk you through how it worked. First, a recap of the trade:

Short June 8100-8300 Strangle; Long July 7900-8500 Strangle

Since we posted this on 22nd evening, let’s begin with prices on 23rd morning 10am.
June 8100-8300 Strangle was 127.7 (PE + CE = 68.2 + 59.5)
July 7900-8500 Strangle was 128.3 (PE + CE = 67 + 61.3)

At end-of-day today, here’s how these two spreads stand:

June 8100-8300 Strangle is 65.6 (PE + CE = 59.5 + 6.1)
July 7900-8500 Strangle is 119.1 (PE + CE = 84 + 35.1)
Now, how much has the trade made?
On the June Short Strangle: 127.7 – 65.6 = 62.1
On the July Long Strangle: 119.1 – 128.3 = -9.2
Net Total = 62.1 – 9.2 = 52.9
52.9 points on a 1 Lot of Nifty, which is 75 in quantity, is Rs. 3967.5. Putting on this trade with a broker such as Zerodha would have required Rs. 70,000 in margin. That makes it a 5.6% return. Reduce transaction costs (about Rs. 240 on Zerodha) and it’ll still end up close to 5%. 
But what about when Nifty was down 4% after #Brexit?
Hmm, let’s see. The low on Friday after it became clear that the Leave campaign had won and the GBP fell more than 9%, NIFTY touched a low of 7927 at 12:35pm, or -4.15% from the previous day’s close.
Scary, right?
Here’s how the position’s P&L stood at that point: -28.6 points. For a lot of 75 Nifty, that is Rs. 2145. Not that scary now, is it?
A probability approach…
Even when the Nifty was down 4%, you saw a loss of Rs. 2145, or around 3%. That loss was only with market values; once they settled, even that would have fallen substantially. The Nifty recovered and we didn’t have to do anything, and as the risk premiums fell with time, we reached a reasonable profit.
You didn’t even have to watch the market like a hawk. Like Jesse Livermore said, the money is not made in the trading. The money is made in the waiting.
When you trade options based on probabilities, it’s not just about risk vs reward. When done right, the third dimension of probability means you will have more opportunities to manage trades at a profit or manoeuvre unfavourable positions, rather than the depend solely on the 19th-century idea of stop-losses.
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  1. “19th-century idea of stop-losses” – Could you please enlighten/elaborate this phrase. By the way nice strategy.

    • Thanks to derivatives, using a stop-loss does not remain the only way to manage risk. The disadvantage with a classic stop-loss order is that it robs you of flexibility. You tend to stop thinking and can get whipped out by just price action noise. With options, you can construct a spread to suit whatever market outlook you have and adjust based on volatility at the time.

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