Understanding the "Option Strategy"

Lesson -> Inclination

1.1 - The framework

Before we begin the module on Option Strategy I want to share with you an article from Behavioral Finance that I found a few years back. It was entitled "Why winning is addictive".

This is the article by B.Venkatesh, a columnist for HBL.

To buy and place a bet on a lotto ticket. This is a game you should avoid as the chances of winning the jackpot are very low. If you win the ticket, however, you'll be tempted to purchase a lotto ticket every day thereafter.

Similar behavior is observed when it comes to investments. What is the driving force behind such behavior? Our lives are governed by our anticipation. It is exciting to look forward to the possibility of winning the lottery, but it is also thrilling to realize that dream.

However, neuroscience research has shown that anticipation of winning is far more exciting than actually winning. However, the thrill of winning a lottery makes you want to indulge. Your brain will urge you to purchase a lottery ticket even though you know the odds of winning the second one.

This is because we tend use more reflexive brain than reflective. The reflective brain does calculation, which helps you think and analyze. The reflexive brain is intuitive and helps you feel. Your reflexive brain is what makes you want to buy a lottery ticket. Your reflective brain will likely tell you that your chances of winning the jackpot again are slim.

Consider trading in equity options. As options can often be worthless, buying puts and calls comes with risk. We may still choose to purchase them frequently, particularly if we have made large returns from these investments. There is another factor when trading options are involved. Options can lead to capital loss if our view of the underlying stock/index is wrong.

It is exciting to be able to win against such odds, even though we may lose some money. This isn't true for lottery, as it is a game based on chance, while investing requires some skill

-End to article

You might be wondering why I posted the above article at the start of this module. This article is a reflection of some of my thoughts. However, it also puts things in the context behavioral finance. One thing is consistent in my interactions with options traders both experienced and new. Options trading is viewed as a "hit or miss" type of trade by most. While there is always an element of fun when you initiate an option trade, most people don't realize the dangers this can cause.

Traders purchase options month after month in the hope that they will double their investment. This mindset makes trading options a disaster for your personal and professional finances. Bottom line: If you want to trade options, it is essential that you do so in the correct way and with the right approach.The gambling attitude will subsequently lead to the entire treading capital consumption and one will end up with a short , destructive & toxic option trading career.

This is something I must mention now. The common phrase "limited risk, unlimited profits potential" (w.r.t. options) is a silent killer for your P&L. This 'theoretically correct, but actually disastrous' fact is what disillusions new traders and causes them to lose their way slowly and steadily. I believe trading blindly without a strategy can be a dangerous but addictive pastime.

This note is not intended to scare you. I am only trying to give context. You would have seen that Options Theory is a heavy-duty topic, unlike other markets. Although it can seem overwhelming, you should not be afraid to ask questions. The best way to learn and master options trading is to structure your learning path using a mix of theory and practical.

This module will give you an overview of some of the most popular options strategies. As usual, I will stick to the practical aspects and avoid the confusing (and unwanted) theory.

There are approximately 475 options strategies in the public domain. I believe there are at least 100 more strategies hidden in the proprietary books and bankers of traders, brokers and bankers. Considering this, should you be able to access all the strategies that have been made available in the public domain.

The simple answer is no

1.2 - Things to know!!!!

While you only need to be familiar with a few strategies, it is important to master them all. You can analyze the stock market or the stock market and then map it using the option strategy you have in your strategy book.

This being said, we'll discuss some strategies.

Bullish Strategies

  1. Bull Call Spread
  2. Bull Put Spread
  3. Call Ratio Back Spread
  4. Bear Call Ladder
  5. Call Butterfly
  6. Synthetic Call
  7. Straps

    Bearish Spreads


  8. Bear Call Spread
  9. Bear Put Spread
  10. Bull Put Ladder
  11. Put Ratio Back spread
  12. Strip
  13. Synthetic Put

    Neutral Strategies


  14. Long & Short Straddles
  15. Long & Short Strangles
  16. Long & Short Iron Condor
  17. Long & Short Butterfly
  18. Box

In addition to the strategies discussed above, I plan to also discuss:

  1. For option writing Max pain - few practical features and key observation.
  2. Dynamic Delta Hedging is used to arbitrage volatility

It is planned to discuss one strategy per chapter in order to provide sufficient clarity and avoid confusion. We will have approximately 20 chapters in the module. However, I expect each chapter to be short. Each strategy will be discussed in detail, including the payoff, implementation, payoff and breakeven. I may also discuss which strikes are best given the expiry time. If you are interested in using the strategy, I will also share an excel model.

Kindly note that all the strategies will be discussed here keeping the reference of Nifty Index , one can use these strategies for any stock option.

Here is the most important point I want to make: don't expect a miracle cure in this module. None of the strategies we will be discussing in this module are guaranteed to make you money. This module's objective is to discuss a few important, but basic strategies that can be used correctly to make money.

This is how you should think about it: If you own a car that you love and you drive it well, you can use it for your commute and provide comfort for yourself and your family. If you drive the car recklessly, it can pose a danger to yourself and others around you.

These strategies can make you money if used correctly. If you don't, they can cause a hole in you P&L. I will help you to understand them and show you how to use them. It is up to you to make sure that it works for your needs. This depends on how disciplined and knowledgeable you are about markets. This being said, I am confident that your ability to apply strategies will improve if you spend more quality time in the market.

We will now focus on the Bullish strategies, with the debut of the Bull Call Spread.

Keep watching.