Finally, some action! The Army’s announcement of Surgical Strikes against terrorist camps in PoK sent the Nifty tumbling down over fears of escalation at the border and VIX spiked to above 18, for the first time since Brexit-day. Of course, Uncle Theta could not let it pass, and began weaving his web to trap theta (time decay in options). This is how we played it.
When the market is afraid, use the trusty ratio spread. We’ve used ratio spreads before in StratOptions and also demonstrated many live examples on the #strategic-options channel (In fact, we did one on INFY today, but we’ll write about that another day.)
Ratios are great during IV spikes because you can get a wide breakeven and a max profit just slightly above that level, and a lower, but guaranteed profit regardless of where the underlying expires above that level.
The Surgical Strike news came on 29th and Nifty dipped. On 30th morning, as things settled down and VIX was still hovering above 18, we initiated our position. We sold 150 Oct 8300 Puts @ 59, and bought 75 Oct 8400 Puts @ 79 for a net credit of 39. The strikes were selected, as always, keeping the 1SD level close to the breakeven.
With this Ratio Spread as a downside cushion, we also added a 1SD wide Short Strangle to the mix. We sold 75 Nov 8200PE and 9000CE both at 75.5 each.
This is how the payoff looked. Notice the 800+ points wide breakevens!
On Oct 4, Nifty bounced back to pre-surgical-strike levels and all seemed well. We had climbed a wall of worry. So we decided to roll up our short put leg from the strangle. So we booked a profit on the short Nov 8200 Put by covering it @ 40, and sold the Nov 8500 Put @ 88. In doing all this, our payoff moved to the right by 100 points. Here’s how it looked after this adjustment:
On Oct 7, as Nifty retraced its gains a little, we decided to increase our position size and added another Short Strangle to the mix. This time, we made it an ATM Strange, selling the closest strikes. We sold the Nov 8700 Put and Nov 8800 Call, both @ 157 (Note, the Nifty Nov Future was at 8750 at that time). We did this to take advantage of accelerated decay in option premiums considering the upcoming weekend and the two market holidays (on 11 & 12 Oct) in the following week. Here’s the updated payoff:
By Monday afternoon (10 Oct), the market had drained out decay for the next 2 holidays, as expected. Our position was up a total of 105 points (we need 120 points to make 3% on our Rs. 3L allocation to the strategy). We decided to book it there. Who knows what could happen over 2 market holidays, when other markets are still open?
Over the past 11 months, while the Nifty has gone from 8200 to 6800 to 8900 to 8500,StratOptions is up 30%. All this while, our maximum drawdown at any point in time was less than 2% of our allocated capital.
We hope we’ve been able to show you that picking direction is not the only play in town, and that this has helped you learn not just about probability-based trading using options, but also about position sizing and money management.
Stay tuned to StratOptions 2.0 once we complete 1 full year next month. And cheers to more volatility!
Now, tell them about it: