Robert Kiyosaki in his famous book has given the secret of making money “The easiest thing you can do is copy what rich people do”
I had studied Option & Futures in my management studies and I was amazed by the difference of theory and practicality of Options trading.
As per the textbook the comparison of options buying and selling given the advantage to option buyer.
Assume that Nifty is trading at a market price of 10000 and a Call option with a strike price of 10200, expiry of 30th June 2020, and a lot size of 75 is available at Rs. 50. option buyer risk is limited to Rs. 3750 but if you are an option seller your risk is unlimited.
However, if this is true why do big boys prefer selling options instead of buying it.
- In theory, the risk is unlimited but there are many ways to limit your risk.
- After the execution of trade there are three possible scenarios:
a. Nifty goes down and closes below 10000
b. Nifty goes up and closes below 10250
c. Nifty goes up and closes above 10250
In all three scenarios only one scenario is in favor of option buyer while options seller has 2 scenarios in his favor
Now test this strategy with some practical data.
Strategy 1:- Sell a Call option of monthly expiry with a lot size of 75 on the first day of the trading session of every month 400 points away from the opening price of Nifty. No, follow up action. Buy it back on the closing price of the expiry day. (This is the simplest(dumbest) strategy in options trading)
Let us see the performance of this strategy from 2016 to 2019
While the return looks very small but this is not the real return. Practically, you can create a fixed deposit of 1 lac and pledge it as collateral to exchange/broken and get the return on both.
In simple terms, if you have invested 1 lac in 2016, it would become 1.52 lacs in Dec 2019 on following the dumbest strategy in option selling.
- Option and index data has been taken from https://www1.nseindia.com/
- The purpose of this analysis is only educational. This is not an investment recommendation
- The average rate of return on fixed deposit is 7%.
- Amount earned is reinvested in the strategy
- The margin of 1 lac is assumed to sell 1 lot of Nifty option
- Margin required to manage MTM losses is ignored
- Maintenance charges have been ignored for simplification. You can consider Rs. 600(Rs. 480 brokerage+120 Demat account maintenance charges)