If your view is bearish, you can trade Strip. This strategy is opposite to Strap. The Strip is a modified version of long Straddle.

In a Long Straddle a trader buys ATM calls and puts in the same quantity. However in Strip since his view is bearish, he will buy 2 ATM puts and 1 ATM call.

Here is the construction of the Strip Strategy:

1. Buy 1 Call
2. Buy 2 Puts

These options should be of the same stock/index, strike and expiry.

If the trader is lucky and the down-move actually happens – he will make more than had he implemented just the straddle strategy. Lets look at the following graph:

See that profits from 2 puts are more than 1 call.

Risk is Limited to the price paid to buy the options.
Reward is Unlimited till the expiry of the option.

Please note that the trader can still make money even if he was wrong – but the stock has to move in the opposite direction really fast. The 1 call bought has to beat the cost of buying all the options and still bring in some profits.

When to Trade a Strip?

Suppose a bad news has come and you want to take your chances – you can trade a Strip. Note that technically it is NOT required that you buy only ATM options. You can buy options from any strike but both calls and puts should be of same strike.

One can always ask – why not buy cheaper options of both the call side and the put side. Well yes you will save money but the risk will also increase.

When a news comes in, index and stocks move very fast in either direction. Bad news – means going south, and good means going north.

If the options are far out of the money they will not appreciate in value fast. Chances are even if a movement comes you may not make sufficient money to make the trade profitable. There are two reasons for this:

1. Delta of far OTM options are very small. A 1 point movement in stock will not have much effect on the option premium.

2. Theta will also eat premium everyday. If the expiry is near and the option is still far, it will actually decrease in value even if the stock moving in its direction.

3. After the news volatility crunches. The option premium will reduce anyway. A buyer has to fight this as well.

I hope it is now clear why buying far OTM options is a dangerous game.

How to Trade Strip in the best possible way?

1. Traders don’t try this – but Strip will work better on a stock not on a Index. Because in a stock a movement of 2% is quite easy after a news. However volatility will still be a problem with buyers.

2. Wait for the news to come out. Volatility will crush – you will get options at a cheaper price. But it may crush further. (And this is a big problem. However trading after news is better.)

3. Analyze the news. How bad or good is that.

4. If the news is good trade a Strap. If the news is bad trade Strip.

5. If confused but still bearish, buy just OTM strike 2 puts and obviously that strike is just ITM for the call. You created a Strip highly favoring the bearish markets.

Three things can happen:

1. Stock moves down: Great result. The puts you bought were not very far off from the ATM strike and cheap too. In terms of percentage they will increase very fast. The call will decrease in value – but it will become first ATM and then go OTM. A 100 point movement can bring in good profits. Because when you book profits and sell the call you will still get a good premium. You are already making good profits from the puts. Result: Not a big loss from the call, and great profits from the puts.

2. Stock stays in range: Bad result. If the options you bought were cheap you can hold onto expiration, else you should sell after seeing no movement for the next 3 days. Usually whatever movement has to come it comes in 3 days after the news. Then the news dies down and normal trading begins. Which means there is no point in waiting after 3 trading days. Sell all options bought and book loss/profits.

3. Stock moves up: Good result. The call option was already ITM so, it will have a good delta and will move faster. The two put options bought will lose value fast, but this call option will be bringing in profits. Though since its only 1 lot, you may have to wait for sometime to book profits. Not sure here because a lot of Greeks decide the option price but if the stock moves up 2% up in 2 days – the profit from the call bought should surpass the losses from the puts to a good extend. Remember that volatility has decreased, so 1% movement may not be enough.

Strip and Strap are rarely traded by trades worldwide. The reason being they are skewed towards a direction. Most trades are fed up with directional calls so much so that they start adopting the non-directional strategies. Therefore they buy Straddles.

However with most buyers losing money, after a while they stop trading altogether.

Have you tried the Strip? If yes please share your experiences.

Most retail option traders in India do not know option Greeks or do not care for them. Option Greeks are very vital part of options trading. If you do not understand them, than it is very important to know about them. At least you should have an idea of what they are. Lets discuss them.

The Five Option Greeks:

1. Delta:

It is the amount an option price will move with every 1 point move in the Index/Stock. If expiry is not near, Delta movement is NOT 1 point increase with 1 point increase in the stock. Which means if the stock moves 1 point up, depending on the strike price of the option, the option will move less than 1.

The reason is that you buy option at a lesser price than the stock in cash for the same lot size, so why should you get profits equal to someone who bought the same stock in cash? Of course option buyer’s losses are also less than stock buyers’.

At the money (ATM) options usually have a delta of 0.5. If the stock moves up 1 point – the price of the ATM option will go up by 0.5. In The Money options have more Delta than out of the money options. Deep In The Money options move almost 1 to 1 with the stock. This is reason why some traders prefer buying deep ITM options. If right ITM options will make more than ATM or OTM options.

As an example. Lets assume Nifty at 8000. The 8000 strike price of calls and puts will have Delta of 0.5. Similarly 8100 CE (OTM) may have a delta of 0.4, 8200 CE (far OTM) may be 0.3, and 7900 CE (ITM) may have a Delta of 0.6. Note how they are changing. Deltas are assumed here not real – but you get the idea.

As expiry nears Delta of all in the money options will move very closely with the stock price as there is no time value left. When expiry is very near Delta of all ITM options move towards 1. Delta of all Out Of The Money (OTM) options will move towards zero. Therefore on expiry day the premium of all Out Of The Money options becomes zero and they expire worthless.

Note: Some traders think that a Delta of 0.1 means the option has 10% chance to expire In The Money. Or 0.5 means the option has a 50% chance of expiring In The Money. You got the idea. This is very important figure for option sellers. I do not have any data to prove this to be true. So please take precaution while selling option even if it has a Delta of 0.1.

2. Gamma:

With the movement of the stock someone has to change the price of Delta as the option moves from ATM to OTM and then back to ATM to ITM.

In the example that we described above, when Nifty moves to 8100 – the 8000 CE becomes In The Money and its Delta increased from 0.5 to 0.6, similarly Delta of 8100 CE increased from 0.4 to 0.5. Gamma is responsible for this change.

Gamma controls the Delta. It is the mathematical formulae (a software) that decides the change in Delta based on a 1 point change in the stock. If Nifty goes back to 8000 – the 8000 strike will again become Delta 0.5.

3. Theta:

This factor is known by most traders. Theta is the Time Factor in the option premium. This time factor moves towards zero as expiration approaches. Theta is the amount the premium will decrease for a one-day change in the time to expiration. Theta works on holidays and non-trading days too. Theta behaves differently for different strike prices.

One important thing that needs mention. Considering options expiring in 30 days – Theta for deep OTM (Out Of The Money) and Deep ITM (In The Money) options decrease faster in the first 15 days and almost nothing is left for the last 10 days. However ATM options (and the near strike prices) behave exactly opposite. The speed of decrease in Theta is almost constant till the last 5 days – after this the speed increases rapidly. In the last 1 hour it is the maximum.

Compare Theta to the melting of ice. If you take some ice out of your freezer and observe, you will see that for the next few minutes almost nothing happens, then slowly the ice starts melting. After 10-15 minutes the speed if ice melting increases. The last 2 minutes are pretty fast when the ice totally melts. Theta behaves the same way especially for ATM options.

Option sellers are the one who love to see the Theta of options decreasing – because this is what makes money for them. Most option sellers sell out of the money options – which means they are only selling Theta. They buy back the options when Theta decreases in value significantly to make a profit.

4. Vega:

Is the volatility factor. Vega is the amount option prices will change for one point change in implied volatility. It is a measure of fear or uncertainty in the markets. When a big news is expected – there is uncertainty in the markets – so the volatility too increases. When volatility increases option prices for both calls and puts also increases. When volatility decreases option prices for both calls and puts also decreases. Vega only effects the time value of the options not its intrinsic value.

For example if Nifty is at 8000. Assuming the 7900 call option is available at a premium of 130, then the intrinsic value of this option is 100 (the difference between the spot price and the strike price of the option). The time value is 30. When Vega increases, only the time value is affected. This 30 can increase to say 32 depending on the volatility increase.

Similarly when the news is out and uncertainty dies down, volatility decreases. This in effect decreases the premium of the options. This is where most trades lose money. Vega has such a big effect that sometimes even if the direction is right, an option buyer loses money because Vega decreased.

This happens mostly with call option buyers. Usually when the markets go up, the volatility decreases. Call option buyers are up against Time (Theta), and Volatility (Vega). OTM call option buyers lose money even if the stock goes up because by the time it goes up a significant portion of the premium would already have been eaten by Theta and the decrease in Vega will also reduce the premium.

For them to make money the speed of the stock going up is very important. However put buyers are in slightly advantageous position because usually when the markets fall, the Vega increases and they can benefit. However they are also up against Theta. Here too speed matters, though not as important when the stock moves up.

I am sure you now understand why most option buyers lose money.

In India volatility is called India VIX. NSE (National Stock Exchange) has allowed Vega Trading too. Right now only Futures trading is allowed. But I think too much capital is required for margin. Right now it is only for (HNIs) High Net worth Individuals. India VIX can be found here:

http://www.moneycontrol.com/indian-indices/india-vix-36.html

Lower end of VIX (when sellers get less premium): 10-15
Average VIX: 15-20
High VIX: 20 and above

As an example on 12-May-2014 when the India VIX hit a high of 39.3 because the election results were due, and spot Nifty closed at 7014 the ATM call was at 294 and the put at 244. Total premium a seller would have got: 294+244 = 538

Today is 13-Nov-2014 (almost same days left for expiry for the current month). India VIX is 13.80 (64.88% less than 12-May-2014). Nifty closed at: 8357. Here are closing prices for both 8300 and 8400 strike options.

8300 CE: 122
8300 PE: 42
Total: 122+42 = 164 (69.51% less than total of the ATM options on 12-May-2014)

8400 CE: 61
8400 PE: 79
Total: 61+79 = 140 (73.97% less than total of the ATM options on 12-May-2014)

As you can see for the same Theta left, when Vega is down 65%, the option premium also reduces by almost the same amount.

I hope now you understand how important Vega is for option traders.

Why does premium of options increase when Vega increases?

The reason is simple. When there is uncertainty in the markets no one knows exactly where the markets are heading. The risk during these times are more. The risk is much more for the option seller. Why? Because they are willing to take unlimited risk for a limited profit. When the markets are uncertain and the premium they are getting is not sufficient why would they sell an option and take unlimited risk for a small profit?

For example on 12-May-2014 if the total premium of the ATM strikes was just 150, do you think anyone would have sold these options? If there are no sellers, there can’t be any buyers. And if this happens – options trading will cease to exist. Therefore when Vega increases the option premium also increases to lure the sellers.

5. Rho:

Is the interest rate offered at the banks for a fixed deposit of 1 year. It is the amount an option value will change with one percentage-point change in interest rates. As mostly the interest rates are same for a long period, Rho does not have a big impact on the option prices. Since interest rates are not important lets not discuss this further.

How you can get the Option Greeks while trading?

Your broker should be able to provide you with an option Greek calculator if you are approved to trade options. You may also look online. You need to put in the values like strike price, time left, interest rates etc and the calculator should return the Option Greeks.

How to trade with the help of Option Greeks?

This is a very big topic. You will find books written on this topic alone. However I will tell you what most retail traders do in the US. By default in the US all brokers show ALL the Greeks on a traders screen. They need not use any calculator. Unfortunately in India there is not a single broker that shows them by default. If you know any please mail me or write in the comments.

If they want to sell options, they sell option that has Delta of less than 0.15. Which means they sell deep Out Of The Money options. The idea behind this trade is that the chance of this option to expire worthless is 85%. (1-0.15 = 0.85 or 85%)

If they want to buy, they buy options that have delta of 0.5 or more. Which means they buy At The Money or slightly In The Money Options.

Some traders sell both call and put options – mostly out of the money options. These traders try to keep their trades at Delta Neutral. Again this is a very big topic out of scope of this article. Still I will try to explain in a simple way.

Delta Neutral means keeping Deltas of all the options they sold same with any movement of the stock.

For example if stock moves up – the Delta of the call option will increase. So they will move the position a few points up. Essentially booking profits in the puts and booking loss in the calls – but maintaining the Deltas of the calls and puts more or less same. The idea is to profit when expiry nears. The Theta will decrease rapidly of both the calls and puts when expiry nears. Ultimately both the options will expire worthless.

Profits or losses are known only on the expiry day, or when the trade is closed. If all the delta neutral adjustments resulted in profits then the trader is in profit, else he loses.

Some people write software to automate this trading. Yes you can write a piece of software to automate your trading and strategies. Benefit is that emotions are not involved. I have rarely come across a person who made money doing automated trading.

Frankly it is very challenging to keep a trade Delta neutral. You need to keep a watch on the stock every time and be ready to shift your trades with few points movement in the stock. Lots of trading is involved therefore lot of brokerage also needs to be paid. Profits or not, your broker will thank you for being a Delta Neutral trader. 🙂

If you are on a job or a busy person it is humanly impossible to keep changing your trades to be Delta Neutral. And there is no guarantee of profits either. We don’t trade to waste time and lose money too right? If you are busy and don’t want to trade too much and are happy with small profits month after month I recommend my course. Its much better than wasting money on losing trades that teach you nothing.

This came out to be a pretty long post, still this is tip of an iceberg as far as Option Greeks are concerned. Though, I hope after reading this article you will have some idea about them.

Do ask any questions on them in the comments section. Do you look at Option Greeks before taking your decision on option trading?

More information on Option Greeks can be found here:

http://www.investopedia.com/university/option-greeks/

http://www.theoptionsguide.com/the-greeks.aspx

http://www.optionsplaybook.com/options-introduction/option-greeks/

Though I always promote non-directional strategies, sometimes we as traders want to explore strategies to benefit from a directional movement.

Lets say a news has come in and its a good news. We know for sure that Nifty may move up for sometime at least till people fully digest this news. Strap Options Strategy is good for these times.

Note: Why does a stock or Index gives a knee-jerk reaction when a big news comes in? Because some kind of emotional trading starts taking place. If a good news comes in, most professional traders (who get access to this news much before retail traders) act pretty fast to make a quick buck or two.

Some days don’t we see Nifty jumping up 20-50 points in matter of minutes? Well that was news-based trading. Some big news comes in and a few stocks with lots of weight-age in Nifty shoot up, driving the Index too with them. By the time we, the retail traders realize, its too late. Some of us get caught in a trap (buying high) and ultimately lose money.

So how do we participate in this rally with least amount of risk and still make some money? You can try the Strap Options Strategy.

Lets discuss this strategy:

This strategy is to be traded when your view is bullish on Nifty or any stock. That is when you think Nifty/Stock will move up.

Construction of Strap:

1. Buy 2 ATM Call Options
2. Buy 1 ATM Put Option

Risk: Limited
Reward: Unlimited

Image of the Strap Option Strategy:

As you can see the call side will move up faster than the put side if the stock appreciates in value.

Can you recall something? Isn’t Strap similar to Long Straddle? A Long Straddle is a strategy where a trader has a totally neutral view. There too he buys both ATM Calls and ATM Puts BUT in equal number of lots, whereas in a Strap he buys double the number of ATM calls than puts.

So why should you trade a Strap instead of a Long Straddle when you have a bullish view?

Because if you are right you can make more money from a Strap than a Long Straddle. Calls will multiply 2 folds in profits whereas the Puts will only lose in half that amount. And moreover since option buying involves limited risk, the puts will lose only a limited amount of money and calls will bring in unlimited amount of money. 🙂 (Unlimited is only on paper – a trader must book profit somewhere.)

You must be surprised to know that Strap is not as popular a strategy than Long Straddle and Long Straddle itself is not as popular as direct buying of options. Do you know why? Because when we have a bullish view we all think we are smart enough and can make money and we really don’t need any protection. This is the sole reason why most retail traders lose money. Some lose in lakhs.

Long Straddle is played by many retail trades too. Here the logic is – wherever Nifty goes I will make money – down or up. Aha – only if money making was so easy. Everybody would have done a Long Straddle at the start of every series and made loads of money. Unfortunately we all know its not going to work.

In a Strap there is fear. And the fear is – what if Nifty goes down? Therefore he buys one put for two calls. If Nifty actually falls – the trader will make less profits from put than his loses from calls, but he will lose money, though less. Only exception is that if Nifty moves down pretty fast – than even 1 lot profit from the put will surpass limited losses from the calls. However it seldom happens.

So when and how should you play Strap?

1. When you view is strong and bullish on Nifty or any stock.

2. When the volatility is low.

Note: Usually when a news is expected volatility tends to increase. Because there is uncertainty in the markets. Unfortunately because of this you may have to pay more for the options. This is where it gets very tricky because as soon as the news comes in the volatility gets crushed and the options shrink in value. The trader then gets frustrated. He thinks even if his view was right – Nifty did go up – why is that he is still losing money?

The trader does not realize that volatility decreased and so his option values. That is why its very important that you buy these options at least 5-6 trading days before the news has to come in. It could be that you are in profit even before the news and you can sell them to make a decent profit.

Or, you can wait for the news to come in and let the volatility shrunk.

Unfortunately the problem with this is that Nifty would have already traveled its path – up or down and trader then feels a missed opportunity.

As you can see in both the situations above you have some pros and some cons but my experience says that it is always better to be prepared before the opportunity arrives. Once the opportunity goes it is very hard to make money in the stock market. Yes Nifty may continue the same path for some time, but the shrunken volatility ensures little or no movement in the options values. Which means neither the calls nor the puts will move significantly in premiums.

After a couple of trading sessions the trader seeing his calls and puts eroding in values sells them at a loss. Whereas had he bought them a few days back, he certainly would have been in profits.

3. When the options you are buying are actually ATM or very near ATM.

This is important because if the nearest ATM strike is where the calls are in the money then you pay more for the calls. This is not required. And if they are out of money, then the Put is in the money and you pay more for the put. This again is not required.

Ideally the premium of the calls and the puts should be the same so that you play a fair game. But if its near expiry and not much time is left for the news – you cannot wait for the stock to come to a nearest option in that case you can buy nearest ATM options.

4. When only 5-6 days are left for the current month expiry you should buy the next month’s expiry.

You may have to pay more for the options but at least you will have enough time to book your profits or losses. 5-6 days to expiry means you can lose 100% of your premium if there is no significant movement. This is what happens to most retail traders. They wait till expiry and every money they paid to buy these options goes away.

5. Do not put too much capital on risk.

Though this is a limited loss strategy, you can survive the game only if you are losing a limited amount in a trade. One big blow means you are out of the game forever.

Very Important Note: When playing a Strap do write down your profit and loss target. When anyone is hit you should close your trade. Do not trade on hope. When your profit is hit do not believe that more will come and be greedy. A profitable position today can be in loss tomorrow.

Similarly when in loss do not keep the position open thinking that Nifty will reverse or fall further giving you a profit. Nifty owes you nothing. That may happen or may not – a wise trader should take his profit or stop loss and wait for another opportunity.

Hope that will help you to play Strap the right way. And also give enough knowledge to know when to buy options and why you lose money buying options.

Have you ever traded Strap or the Long Straddle? If yes what was your experience?

This is the last article in the butterfly series.

Here are the rest:

1. Long Call Butterfly
2. Short Call Butterfly
3. Long Put Butterfly

… and this article is on Short Put Butterfly Strategy.

Note that the Long Call and Put Butterfly strategies work when Nifty expiry is very near the ATM strike that was sold. A credit is required to play the trade therefore the trade is called long butterfly.

Short Call and Put Butterfly works when Nifty is more than 100 points away in any direction from the ATM strike on the expiry day. The trader gets a credit therefore its called the short butterfly.

Unfortunately adjustments are costly and are not recommended. Since the risk and reward both are limited – basically a butterfly is a set and forget strategy. If it works – great, else you will have to take a limited loss. Mostly these strategies produce best results on the expiry day. And therefore should be traded 2-3 days before the expiry day.

Since some kind of prediction is required, I personally do not like or trade these strategies.

With the above in mind lets discuss the short put butterfly strategy.

When Should You Trade a Short Put Butterfly?

When your view is that the stock or the Index you want to trade will move at least 100 points away and hopefully will remain there during the expiry. Even if it does not move now, your view is that in due course of time Nifty will move away at least 100 points before expiry. This is a positional trade.

Have you ever noticed that when you want Nifty to move – it does not. And when you do not want it to move – it moves 100 points in no time. That’s stock markets for you. 🙂

Therefore butterfly strategy should be traded when you have a strong view of the spot where Nifty will be on expiry day. Tell me how many times will you be correct?

Its a neutral strategy, but high volatility helps because its a sellers trade and premium is the max profit.

Constructing The Short Put Butterfly Trade

1. Buy 2 Lots of At The Money Put Options
2. Sell 1 Lot of In The Money Put Option
3. Sell 1 Out of The Money Put Option

Risk: Limited
Reward: Limited

Let me get the real closing prices of the options that I will now show you as an example.

Date: October 28, 2014

Nifty Spot: 8,027.60 (markets closed for today)

Will treat 8000 as our ATM strike. Options prices are for options expiring on 30-Oct-2014.

Lets trade:

Buy 2 Lots of 8000 PE (ATM): 16.20 (16.20 * 50 * 2 = Rs. 1620/- Debit)
Sell 1 Lot of 8100 PE (ITM): 66.25 (66.25 * 50 = Rs. 3312.5/- Credit)
Sell 1 Lot of 7900 PE (OTM): 3.30 (3.30 * 50 = Rs. 165/- Credit)

Total Credit: 3312.5+165-1620 = Rs. 1857.50

Note: It does not make sense to sell a lot with a premium of 3.30. I know people do it on the expiry day. Frankly it is not a good strategy to sell options on the expiry day. The risk-reward is pathetic. Just imagine even if you are getting 5 points – that is getting Rs. 250 in one lot for unlimited risk. Is that justified? This is off-topic – but if you are selling options on the expiry day, you are doing a big mistake. Yes it is great to see options you sold expiring worthless and those last few moments are so exiting. But are you trading for fun or to make money? What if something goes wrong? You may have a huge loss. There are better trades. Please stop selling options on expiry day.

Ok. Coming back to the trade. Even though it does not make sense, technically to complete a short put butterfly, I had to do it.

You know what I will do in such a scenario? Being very practical, I will do the rest of the trade but not sell 7900 PE. There are still 2 days left for expiry. I don’t need that Rs. 165/-. That is the max I would gain and frankly it does not bother me. So I will take my chances.

What if next day Nifty suddenly moves down 50-60 odd points, or gaps down 100 points? May be that OTM option will then become 30 or even 50. I will then sell that option and complete the Short Put Butterfly trade. That way my returns will be more. This is called legging into a trade – but lets reserve this for another day.

If you have read the other butterfly trades I have written in my website, you would have realized by now that the butterfly trade is a set and forget trade. You should set it near expiry and close it at around 3.15 pm on the expiry day.

Assuming that we waited for the expiry day, lets calculate our max profit and loss.

Assuming Nifty closed exactly at 8100. (Today is the Oct 14 series expiry and Nifty closed at 8169 – so had I done this trade I would have made the max profit :))

Buy 2 Lots of 8000 PE (ATM): 16.20 – Expires worthless. (16.20 * 50 * 2 = -1620 Debit)
Sell 1 Lot of 8100 PE (ITM): 66.25 – Expires worthless. (66.25 * 50 = Rs. 3312.50 Credit)
Sell 1 Lot of 7900 PE (OTM): 3.30 – Expires worthless. (3.30 * 50 = 165 Credit)

Total Profit: 3312.5+165-1620 = Rs. 1857.50
Anywhere above 8100 closing the results would have been same.

Assuming Nifty closed at 8000:

Buy 2 Lots of 8000 PE (ATM): 16.20 – Expires worthless. (16.20 * 50 * 2 = -1620 Debit)
Sell 1 Lot of 8100 PE (ITM): 66.25 – is now 100. Loss 100-66.25 = 33.75 (-33.75 * 50 = -1687.50 Debit)
Sell 1 Lot of 7900 PE (OTM): 3.30 – Expires worthless. (3.30 * 50 = 165 Credit)

Total Loss: -1620-1687.5+165 = Rs. -3142.50

Assuming Nifty closed at 7900:

Buy 2 Lots of 8000 PE (ATM): 16.20 – is now 100 (100-16.20 = 83.8 * 50 * 2 = 8380 Credit)
Sell 1 Lot of 8100 PE (ITM): 66.25 – is now 200. Loss 200-66.25 = 133.75 (-133.75 * 50 = -6687.5 Debit)
Sell 1 Lot of 7900 PE (OTM): 3.30 – Expires worthless. (3.30 * 50 = 165 Credit)

Total Profit: 8380-6687.5+165 = Rs. 1857.50
Anywhere below 7900 closing the results would have been same.

Return on Investment (ROI):

Assuming Rs. 25000 is blocked for 1 lot Nifty option shorting. 2 options were shorted = Rs. 50,000.00 and Rs. 1620 for the option bought. Total margin blocked = Rs. 51620.

If profit: (1857.5/ 51620)*100 = 3.59%
If loss: (-3142.50/51620)*100 = -6.08%

This means you are risking 6.08% to make 3.59%. For some this is good risk-reward, for some it may be bad. For me it does not matter, since this involves predicting I would rather not trade the Short Put Butterfly Strategy.

This does not mean you should never try this strategy.

Best Time to Trade the Short Put Butterfly Strategy

1. Trade when the expiry is near. Why? Because this is a set and forget till expiry day trade. Your money will be blocked for a long time if you trade much before expiry and risk-reward will be almost same whenever you trade. Why would you block your money for so long? I would trade this just 3-4 days before expiry.

2. Trade when volatility is high. Why? Because you get high premium. Yes you also pay more for buying the ATM options – but if volatility is high you may also get more premium. Remember the total credit on the day you trade is your max profit.

3. If a big news is expected 1 or 2 days before expiry it helps. Why? Because the news will have some effect on the markets. For example yesterday night (India time) a big news came – Fed ended quantitative easing. (Quantitative easing is a funding system where Fed buys billions of dollars worth of bonds every month to pour a giant amount of money into the world economy. Some money of course used to find its way into Indian markets.)

This was a big news awaiting Indian and world markets. This news was coming just a night before the expiry day. Thus during such times the short put butterfly and the short long butterfly trades becomes excellent trades, because there is a high chance that Nifty will move someway or the other. For example today Nifty closed at record highs. It closed almost 1% up from yesterday’s closing. It closed at 8169.

4. If you are getting negligible premium by selling one leg of the trade, you can wait to sell it another time for a better premium. But the choice is yours. In the above case we would have lost that 165 Rupees.

Any Adjustments for the Short Put Butterfly Strategy?

No. Set and Forget. The results will come on expiry day. You know your max risk and max reward, why bother with adjustments. If you rollover your trade then only your broker will make money not you.

So Should You Not Take Any Stop-Loss As Well?

Well frankly this is very tricky to answer. If Nifty does not move, you will start getting bit nervous. If your max loss is something that you can digest, my suggestion is that its better to leave the trade for the expiry day. For example today itself Nifty moved 1%, almost all of that intraday.

Had a trader taken a stop-loss in the morning he would have felt bad. And interestingly that trader would have blamed his bad luck because Nifty moved after he took a stop loss. Was it really his bad luck? Or he did not have patience? Therefore trade with limited number of lots and max loss you are comfortable with, and leave till 15 minutes before expiry.

That ends the series on butterfly trades. Have you ever traded the butterfly. I am sure most of you do. If yes what did you trade? Did you make a profit or loss? Do let me know in the comments section.

Note: From tomorrow Nifty Lot size will reduce from 50 to 25 and the margin blocked will also drop by 50%, so please calculate the profit and loss accordingly.

I have already discussed how to trade Long Call Butterfly and Short Call Butterfly. This article discusses how to trade a long put butterfly.

Note: Most traders I have talked to like to play butterfly with call options and not with put options. I think it has more to do with human psychology than anything technical. We love to buy call options more than the put options, don’t we? I do not know the reason why, but I think we perceive markets going up more rather than down.

The fact is, it does not matter what option you are choosing to play a butterfly with, the risk reward will remain the same. Whether you trade a long put butterfly, or a long call butterfly – the risk and reward will be same.

When to Trade A Long Put Butterfly?

You should trade a long put butterfly when you have the view that the markets will consolidate for a few days. If Nifty does not move much and remains range-bound, you should be able to profit.

Risk: Is Limited
Reward: Is also Limited

Long Put Butterfly Trade:

1. Sell 2 ATM Put Options
2. Buy 1 Immediate ITM Put Option
3. Buy 1 Immediate OTM Put Option

Let me take a live example of market closing rates on Monday October 20, 2014.

India VIX is at: 14.19 (It is down 13.48% from previous close. But since you will be both a buyer and seller of nearby options – INDIA VIX does not have a big role to play in your trade. So while trading long put butterfly, your view is important – volatility cannot do anything to help or harm you. However if the volatility is high, it will help you to get good credit while selling ATM options, unfortunately you end up paying more for the other options bought. Vice versa when the volatility is low. As you can see volatility does not have a big role to play here. Though high volatility may bring in slightly more profits not significant.

Spot Nifty: 7879.40 (We will treat 7900 as ATM strike) Lets get the last trading prices of current month options expiring in 10 days from today:

1. Sell 2 7900 Put Options: 67.10
2. Buy 1 8000 Put Option (In The Money): 127.80
3. Buy 1 7800 Put Option (Out of The Money): 33.05

Calculations:

Sell 2 7900 Put Options: 67.10 * 50 * 2 = 6710 (Credit)
Buy 1 8000 Put Option: 127.80 * 50 = 6390 (Debit)
Buy 1 7800 Put Option: 33.05 * 50 = 1652.5 (Debit)

Total Investment: 6710 – 6390 – 1652.5 = Rs. (-)1332.50 (Debit)

Margin Blocked (as per NSE guidelines): 25,000 per option sold, 0 for OTM options bought, full money blocked for ITM option bought:

25000 + 25000 + 0 + 6390 = Rs. 56390.00 (Approx)

Now assuming that the trade finished perfect. One the expiry day Nifty is at 7900:

Sell 2 7900 Put Options: Expires worthless. The trader keeps the credit of Rs. 6710.00

Buy 1 8000 Put Option: is now at 100. Loss 100 – 127.80 = -27.8 * 50 = -1390

Buy 1 7800 Put Option: Expires worthless. The trader losses the money paid to buy this option: -1652.50

Total profit: 6710 -1390 -1652.50 = Rs. 3667.50

Return on Investment: (3667.50/56390) * 100 = 6.50% in just 10 days.

Isn’t this a great trade if it works well?

But I do not recommend trading butterfly. Lets see the reasons why?

Supposing the trade did not work well and Nifty is just 100 points up (at 8000) on the expiry day:

Sell 2 7900 Put Options: Expires worthless. The trader keeps the credit of Rs. 6710.00

Buy 1 8000 Put Option: Expires worthless. Loss 100% of the cash to buy it: -6390

Buy 1 7800 Put Option: Expires worthless. The trader losses the money paid to buy this option too: -1652.50

Loss: 6710 – 6390 – 1652.50 = Rs. -1332.50 (The initial cash invested to trade this strategy)

The results will be same if Nifty is anywhere above 8000.

Lets look at the lower end. Nifty is just 100 points below 7900 or 7800 on the expiry day:

Sell 2 7900 Put Options: The 7900 option is at 100. Original value: 67.10. Loss 67.10 – 100 = -32.9 * 50 * 2 = -3290.00

Buy 1 8000 Put Option: Is now at 200. Profit: 200 – 127.80 = 72.2 * 50 = 3610

Buy 1 7800 Put Option: Expires worthless. The trader losses the money paid to buy this option too: -1652.50

Loss: -3290 + 3610 – 1652.50 = Rs. -1332.5 (The initial cash invested to trade this strategy)

It does not matter where is Nifty below 7800, the trader will suffer the same limited loss.

Lets calculate the loss percentage.

NOTE: This is also very important from trading point of view. As a conservative trader, I want to know before trading what is my Max loss in the trade. If I am not comfortable losing that much money I do not trade or reduce the lot size.

(-1332.5 / 56390.00) * 100 = -2.36%.

Yes the risk-reward of -2.36% to 6.50% in just 10 days looks very attractive and traders get attracted to the Long Put Butterfly or the Long Call Butterfly, due to this. But unfortunately most butterfly trades are losers. WHY? Because a 100 point movement can come anytime – even in 1 hour. How can you avoid that?

The trade looks good when initiated, but as time passes and Nifty starts to move in any direction – you will start feeling the pinch. Traders are left hoping and praying Nifty does not move. With this trade what you are essentially hoping is that from the second you put the trade, Nifty should remain in a very tight range. How many times will that be possible? Possibly 1 in 10 times.

Is there any adjustment strategy to the Long Put Butterfly?

No. The only thing you can try doing is to move your trade where Nifty goes, you want your sold strike to remain ATM. Frankly, every time you do this, you will lose money. By the time the expiry day arrives, you may have lost so much money that even if Nifty expires at your new sold strike position – the profits will not be enough to cover the losses done while adjusting. The whole experience will also frustrate you. As you may have done a number of adjustments and even after Nifty finishing where you wanted, the trade was a loser. Your broker was a winner though. 😉

The only way out is to trade this when the expiry is very near – like today – expiry is just 10 days away. Or trade even just 5 days away as the risk and reward is limited. However after that your only job is to hope that Nifty finishes where you want it to be on the expiry day – adjustments if any will cost you. Close the trade at 3.15 pm on expiry day. If you made a profit, consider yourself lucky – the trade had nothing to do with your profits. 🙂 Do you really want to trade this now?

This is the major reason why I discourage any trade that requires any kind of prediction. If you want to predict – predict for the worst outcome – you will become a better trader. I encourage you to try non-directional trades where almost no prediction is required.

Today is Diwali 2014. Here is wishing you all a Very Happy Diwali and great trades in the future.

I hear a lot of stories on how people lose money trading options. Most of them are not worth sharing. But this one stands out and I thought I should share this with visitors of my website who are looking to buy that option for a big home-run.

Update: 40 lakhs looks too small compared to this aggressive trader who lost more than Rs. 2 crores trading options aggressively. You must read about this trader too.

I do not think anyone in this world exists who has had a real home-run buying options (I mean made so much money buying options that they can now stop trading and live a comfortable life). Yes, you will find people who are doing well trading options – but they have a solid strategy that they master.

Note: I have also written earlier why buying options will not make money over a long time. This post gives you a real example how things can go horribly wrong.

Recently I received an email from one one person from a small town in West Bengal, India. I have got his permission to share his email with this website visitors. If you are also looking for that home-run buying options you should read it:

Hello Mr. Dilip,

I stumbled upon your website from Google after searching for a low-risk options trading strategy for Nifty. And today, the whole day I was reading almost all stuff at your site. I can remember, while reading at your Yes Bank and IDBI trade, I myself and my uncle made an options purchase from a veteran trader’s call in a stock trading forum, that gradually worth around 6 lakhs went to zero, and we ended up loosing everything.

That was start few years back and by now I have donated most of the money to the market what I have earned from my now dysfunctional business – around 40 lakhs or more. Tried everything, Commodity, Futures, Pair-Trading. Less tried are Currency derivatives and Equity.

Now I can’t take any unknown risk. And at this moment, I am at a very crucial point of my life. I am 41 years old, have wife and two little kids. I have no job except some 15 lakhs FD that earns some interest, and around a 5 lakh trading A/c.

Right at this moment, I can’t have the luxury of loosing money any more. I know, whatever I have given to the market is just my mistake, I accept all the responsibility, because always I have placed large bets even after reading Van Tharp position sizing book. How silly I am – I always wanted to have that big home-run.

And I burnt my hand always.

Now I think it is the time to get all those money back with a constant rate. I do not want very high return, but a 5-6% per month steady return as per your strategy in any market condition and peace of mind will just do. Because, right at this moment, I am just looking to take care of my family, at least 30K per month is enough for me at this time.

Can you please help me?

Regards,
Name withheld

Isn’t this sad to read? Not only he lost lots of money, but he also lost a lot of time. Money can come back, time will never. A person who was once making 2 Lakhs per month is now dying to make 30 thousand per month. I know its painful, but greed took all money from this investor.

I asked him to first look for a job as a high priority. He has two kids and he is responsible for their well being and giving them good education. My course can of course come later.

I also told him if it was possible then he should again start that old business. He must be good at it that is why he was making so much money. That business was making him more than 2 lakhs per month, I see no reason why it cannot make 25% of that now.

Even a job paying 15-20k per month should be fine for him now. It will help him to meet the monthly expenses of his family. This will also ensure that he need not touch his bank fixed deposits.

If you are reading this and are in a similar situation, please take up a job as soon as possible. Then learn trading and start trading in small quantity. Once you are confident, only then increase your trading size. Do not fall for greed.

When I asked him why he did not stop at around 10 lakhs loss which is still bearable, he gave me a good reply.

Dilip, if you study Quantum physics, you will find that everything is vibration. When I earned that money month after month, it was my disbelief or low vibration about money in my Subconscious Mind that self-sabotaged me and took away all the money. At that stage, when I was earning even more than 2 lakhs per month in some months, my Subconscious Mind definitely rejected that idea or vibe – thought it was artificial or inflated and found a way to destroy that wealth and led me to join Stock market.

During six-month study period of your course, I must raise my vibration to a much higher level and must match those frequency at which that amount of money will manifest; otherwise nothing is going to happen for sure.

You may not believe, but it is true, if you wish, you can read a book called “Psycho-Cybernetics” by Maxwell Maltz.

http://en.wikipedia.org/wiki/Psycho-Cybernetics

OK may be this is true, but I still feel one should put a stop to ones greed.

Lets assume that he actually made 80 lakhs by buying options using the 40 lakhs money he had in his trading account. Do you think he would have stopped there? NO. His next target would be 160 lakhs and so on. Do you think he would have been successful every time he traded? Eventually he would have bought some option that would have expired worthless. He would still say the same story. It does not matter if he made 80 lakhs from 40 lakhs then lost it all – what matters is that he lost and he lost due to greed.

So, what are the lessons we can learn from this story?

1. Greed is bad in trading. Stick to your profit target or loss. Do not hesitate to take a stop loss if trade is not going in your favor. Also when the required profit target is met, do not hesitate to book profits. Waiting for more profits may take the trade back to losses. Similarly waiting for the trade to turn in your favor is futile – you will incur more losses.

2. Do not force yourself to trade. Just because you think an option will double in few days time does not mean you are correct. If you are not comfortable, just do not trade. Ask yourself before placing any trade – are you taking a big gamble? If the answer is yes – you are getting greedy and you should not trade.

3. If you want to speculate – then speculate for the worst possible outcome from a trade. Keep a plan ready when it actually happens. Stop loss or adjustments – keep it in writing.

4. Discipline is important. If you have only 10 lakhs to trade and have decided not to bring in any more money to your trading account, then do not bring any new money into it. That money may turn to one crore or zero. At least you will have the rest of the money to live your life and support your family. Read this to know how to manage your financial portfolio.

5. Money made from the stock markets is not free money. It comes with education, stress, strategy, planning and discipline. Do not disrespect this money. Psycho-Cybernetics or whatever is only an excuse – your money will not come back neither the time. If you are reaching your goals, slowly start withdrawing the profits from the trading account and put it in a liquid fund or bank FDs. Life has a limit – what makes you think that you will be trading forever and making money?

6. Share your profits and losses with your spouse. They have a different psychology and mindset than yours. I am sure he did not share his losses with his wife. Had he done that she would have asked hom to stop and concentrate in his business rather than the stock markets.

7. Always hedge your positions. That way even if you lose in one trade, the other trade will bring in some profits. If you are playing naked options, and if there is a huge gap up/down and your position is not hedged, you may lose massive money. You may never even get to take the stop loss because you will have lost it all.

8. Get some trading education. If you feel you are comfortable buying stocks – learn which stocks to buy and when. If you love future trading – know how to hedge them in the best possible way. If you love options trading – learn how they work, what are the best strategies that work.

9. Give the biggest priority to the source that generates the most income. If its your job – take it seriously. Work hard. Try to increase your salary. If its some business then read more about it. Master the craft. Become the best businessman in that field. If its stock market trading then do not stop learning even if you are the best in the world. Target small profits every month and be satisfied with them. Small profits will add up a huge amount in few years. Do not try for a home-run. It will slowly bleed you to financial bankruptcy and believe me you will never know. You will only realize when you will have already lost a substantial amount.

10. Greed and Fear both are your biggest enemies in trading. I am sure many of you are good traders but just do not trade because of the fear of losing. Interestingly even those who fear lose money. If you are good in trading but fear increasing your lot size then over a period of time you will end up losing even more than what greedy traders lose. Unfortunately you will never know. Don’t we hear stories from our friends/relatives who say, “Alas, if I had invested in so and so stock at that time I would have been a crorepati by now”. Well that was fear. Can you see one lost investment here is equal to one crore?

With this article if I am able to help you understand that Greed is not good neither is fear then I feel I have done my job. Learn to balance them and I bet you will become a good trader.

All the Best!

Most traders, not just in India but the whole world wonder if they can make enough money from trading to live a comfortable life. Yes the real question is if they can leave their day jobs and make similar amount trading the stock markets to feed their families.

Well frankly I really don’t get this. Why everyone want to leave their jobs? Lets keep it for another day.

I get many phone calls and mails asking something similar on the above lines. However recently I got this email from one of my subscribers Mr. Chandirasekaran which is quite interesting and I would like to share his question too. I have taken his permission. My answer follows the question.

Hi Dilip Shaw,

Fantastic article on how to manage our finances!

I also agree with your views on Gold and property. Gold is not very lucrative over longer periods compared to equity. Similarly property is illiquid and not suited to middle class people like us as you rightly mentioned.

By the way I wanted to ask you something. Its inspiring to know that despite 7 lakhs loss, you have learnt some hard lessons and finally came out of it and now able to generate sustainable income.

Now I just wanted to know whether you are able to make money on an annual basis at least 70% of your last salary from options/equities etc. consistently? I mean whether you are able to meet all of your family monthly expenses and also able to lead a comfortable life?

Thanks & Best Regards,
Chandirasekaran

This was my response:

Hi Chandirasekaran,

Thank You for the kind words. 🙂

If you read my article here:

http://www.theoptioncourse.com/strategies-can-help-grow-money-power-compounding/

You will find this:

Most traders who take my options trading course ask me what I do with the profits earned with my trades. Well I believe in power of compounding. Frankly right now I do not need the money that I make from trading or the stock markets. So I would rather make sure I am compounding it. If I take it out and do not use it, and assuming I keep it in my bank account – it will grow at only 3.5% per year. Compare this to almost 3% per month. So where should I keep my profits? Of course I should reinvest it. If I keep re-investing in my trading account it will grow much faster than if I put it in my bank account or even an FD.

You got your answer. I strictly follow the 25-25-25-25 rule. (25% of my savings goes into Government backed securities like FD, PPF etc, 25% goes into 4/5 star rated mutual funds, 25% goes into direct equity buying of companies with strong management and the rest 25% comes into my trading account. However since my limit of investing in the trading account is reached I do not add any more money into it – but do not withdraw the profits as well – so indirectly I am investing into it. For more detailed info read here.) Even if I want my wife will not allow me to invest more in my trading account. She cannot forget the bad times, and even today the pain is in me. In 2011 I really had a tough time to convince her to put some money out of our savings again into my trading account. It came out to be a good decision.

However it does not mean I am not investing more into it. The profits generated are also earned money right? So investing 100% of the profits back into my trading account is also the same as bringing new money into the trading account. Essentially I do not feel the necessity to add any extra money to my trading account. Another reason is my limit of bringing new money into my trading account has been reached, so that law does not allow me to bring any more money. Yes temptation is there but I will not fall for it. However by not withdrawing money I am increasing my trading kitty. Hope its clear, bringing more money into the trading account every month or investing the profits back into it is the same.

To answer your question – my account is still not that big that I can withdraw money from it every month and live a comfortable life. But if I keep going at this rate – eventually in 4-5 years I will be able to leave my part-time consulting job. But frankly I love my job, so I am not sure if I will leave it soon.

I understand why you asked this. Most people who call me ask the same question. Can they make enough from trading to live a comfortable life?

Well it depends on your needs, the kind of profits you can generate from trading and cash in your trading account.

For example Family A may need Rs. 50,000 per month to live comfortably. The head of the family is smart and makes 10% profit per month, but his trading account has only Rs. 1 Lakh. He cannot leave his job at least now.

Family B may need 1 lakh per month. They generate 5% profits per month and their trading account is 20 Lakhs. Yes target met. Their bread earner can leave his/her job.

You get the point. Your family needs, the profit percentage and cash in trading account – all will have to be taken into account when someone decides to leave his job and fully depend on profits generated from trading.

Frankly you will find few people doing that. Even hedge fund managers have a job. Mutual fund managers have a job. You need a lot of money to make a lot of money. But one can get there, it only needs determination, hard-work, patience and a step by step approach. It will take time.

Since Mr. Chandirasekaran asked me this question, I will try to explain it as a normal retail trader. But please assume that it could be you.

In a worst case scenario at 2-3% a month a 10 lakh account may be making anywhere between 20,000 to 30,000 a month. For me that is not enough. I need to make at least one lakh a month to live comfortably. For that around 40 Lakhs is needed. When you have 40 Lakhs to trade it has to do with traders mindset as well.

1. If I have only 40 Lakhs as savings – it is foolish and suicidal to keep 100% of it in a trading account. One silly mistake can take it all. What if by mistake you press the “sold” button and thought that you have actually “bought” and did not see the order/trade reports or the Contract Notes. Yes it is a rare blunder – but what if this happens? We are humans and we can do mistakes right? After a few days you check to see that option has doubled and eventually when you wanted to book profits you find that you have lost a lot of money because you did a silly mistake. Remember you will not get back this money.

(On the day I trade in the evening I check my email to see the Contract Notes. This essentially makes sure I double check my trades – one in my trades report and second in my Contract Notes. All traders should do this as well. This will ensure a 100% accuracy in trades. If you have done a mistake you can rectify the very next day.)

2. Even if you have more money stacked somewhere you will get stuck with two choices:

a) If you keep 40 lakhs in a good debt fund or FD it will give you a return of around Rs. 30,000 per month without any work or stress on your part. Compare this to all the hard work and stress required for trading.

b) If you have 40 lakhs more in FDs or whatever you tend to be complacent. You try to get aggressive. Why? Because you have a lot of money (around 80 lakhs) – now you want to make even more “lots of money”. Greed leads a trader take huge risks and lose a lot of money. One trader a few days back called me to say its ok for him to lose Rs. 30,000/- per month but not more. WHAT? He is willing to lose that much per month. Why? Because he generates 1 lakh in interest per month. Frankly I think he does not need any more money – he wants to trade to pass his time or try aggressive trading to make loads of money. Probably just to satisfy his ego. People trading to pass time/kill boredom/have fun and/or aggressively trading to make a killing – all are doing a big mistake. They will most certainly lose money.

One trader with more than 1 crore in his account took my course. I asked him why is he taking my course? He already has a lot of money, so what is the need to trade with so much money? (Well there is nothing wrong to trade with a one crore account, but I just wanted to ask. How many times do you get an opportunity to talk to a retail trader with a one crore account? As a trader I wanted to know his psychology.) He said that he loves to double his money.

Well here is the story: He started with a few lakhs, took the account to one crore and on that day was sitting on a unrealized loss of 90 lakhs. Like I said these people take unlimited risks, because they have unlimited money and they do not care.

It comes back to the same question – can you generate enough to make a living out of trading?

Yes it is possible, but you will have to do a serious introspection on why you want to do this. Firstly ask yourself why you want to leave a lucrative job? If you love your job – what is the need to leave it? Is your job hard work? Well trading is also hard work. It is not a cake walk else everyone would have been successful. But if you really hate your job and are serious enough to trade and make a living out of it here are the steps you need to take in order to reach there:

Step 1) Invest money in stock trading education. There are books, websites and people offering education. Get education from reliable sources. Learn some trading strategies.

Step 2) Start paper trading on the strategies you are comfortable with. When you are paper trading be serious. Treat this as real business and real money even if no money is involved. When paper trading I recommend trading with at least 10 lots or more. Remember no money is involved so you should learn as much as possible. With 10 lots you will make or lose a lot of money – this will help you to understand what happens when you will trade with a lot of money.

Write the trades in a notepad or excel sheet. You should also approximately deduct the brokerages even if this is paper trading. This will help you to calculate real ROI. Paper trade for 3 months at least. If you are making losses. Go back to Step 1. It means your knowledge is lacking or your strategies needs improvement. Come back to Step 2. Again practice for 3 months. If profitable even 1 percent, go to step 3.

Step 3) You are now confident and ready to trade. Take some money out of your savings (at least one lakh) and put it in a trading account. Make sure your trading account is with a discount broker charging Rs. 20/- or less per trade not per lot. This will save you a lot of money on brokerage.

Step 4) Its time for real trade. Trade small in one or two lots only, even if you feel great and want to go all out. If you are successful for 3 months, increase the trades with 1 lot.

After one year consider yourself successful trader if you have done at least 50 trades and made even 1 rupee profit. Yes its good enough to break even in your first year of trading.

Now if you feel money is short, this is the time to add money to your trading account. You are making profits – there is nothing wrong in adding money to a small account. Add small and a fixed amount every month. However you should keep an overall limit. Like this it will take some time but eventually you will reach a point where you will be comfortable trading and making enough to support your family.

Step 5) Leave your job when you are 100% sure you can make a living out of trading.

Step 6) Do not get aggressive and take huge risks when your account has grown big. You may not believe but this is the most difficult step to follow. As I have said people with huge accounts rarely make money because losing a few thousands every month mean nothing to them as they want a big killing trade. For this one trade they keep taking big risks and keep failing until they realize their account is fully blown up. At this time it is too late to recover.

There was one option trading firm in USA that lost years of profits in just one bad trade. I hope if you are already there or will reach there one day, will remember this article and not commit such a blunder.

In the whole process keep your spouse in the loop. Profits and losses should be shared. Why? This will stop you from taking unnecessary risks. In the back of your mind if you know that you are answerable to someone, you will never take big risks. Sharing your profitable trades will make you happier and sharing your loses will reduce the pain. It looks trivial but it works.

As you can see growing slowly is the mantra. Compound your money to such an extend that you feel comfortable leaving your job. If you take it step by step – that day will come sooner or later. But if you want to jump and reach there fast – you will fall and fall badly.

I hope you got the answer.

All the best to all those who want to accomplish this, and of course to other traders as well.

Many Thanks.

One of the best things about this website is that I come to know some amazing and some not so amazing traders in India.

Well unfortunately most traders are losing money. 🙁 Why people lose money is that they do not have a trading plan to execute when their prediction goes wrong. They simply do not know where to take a stop loss or to book a profit. I mean when you trade you should have a trade plan in place. You should know clearly when to take a stop loss and when to take out profits.

If you take a stop loss at 50% of your profits – even if you are right 50% of the times – you will make money. Risk management is the most important decision in trading which everyone forgets.

Some get too aggressive and lose money. (Aggressive traders lose the most). Some book profits at an early stage when more profits may have come. Some just start praying to Gods for help when losing money. I mean what can Gods do if you never had a trading plan or you over-traded? Some hope that one day before expiry Nifty will reverse trend and they will be able to book profits. And you know what – it gets worse on the expiry day.

Trying to make money on hope and praying to Gods when in trouble is a different chapter of trading altogether. Out of scope as far as this article is considered. 🙂 (BTW I have been there done that 😉 )

If these are your trade plans, how on earth you are going to make money?

When I lost 7 lakhs trading I thought I am one of the worst trader in the world. The day my losses touched 7 Lakhs I slapped myself – yes literally slapped. How can greed overcome me? How can I lose so much? I was young – I could have just kept the money in a FD and it would have grown at least 50% in 4 years. But once money goes it goes – it never comes back. You will have to work hard to make more money. This hard work has nothing to do with the lost money. That one pain is going to stay for long.

Today I consider 7 Lakhs as tuition fee to the stock markets. Today I know that 7 lakhs I lost was nothing compared to what some big traders lose. At least I stopped there, learned a lot from my mistakes and started learning options trading.

But traders out there just do not want to learn. If they earn a rupee they think they are smart and can earn more. And when they lose double that they blame on luck. This continues until losses runs into lakhs.

Read this and you will be in shock too. Some of the traders are running in losses amounting to tens of lakhs. One of them living in a small town in Andhra Pradesh is currently sitting at MTM (mark-to-margin) loss of Rs. 90,000,000.00 (90 Lakhs). Are you nuts? I mean most people on Earth cannot even earn that money in a decade and here is one guy who is just destroying his wealth. All this in span of two months. When I asked him why he did not take a stop-loss he said he hates taking stop loss. What an answer. Trading is a business and when in loss – you should take a stop loss or hedge your positions.

There is more. He told me there are many more people in that town who have lost more than that amount. If a small town in AP can have retail traders trading with more than 1 crore capital, then imagine how many traders are there in India trading with that much capital?

Another software engineer was sitting at a real loss of 45 Lakhs. He buys options. Well if you also do the same take this as a warning.

If its true that 95% of retail traders are losing money – imagine how much money is being sucked from the retail traders by the FIIs, DIIs, and smart retail traders.

I have found that losses do not accumulate in a day. If you put a frog in hot water, it will jump to save his life. But if you put it in cold water and boil it slowly – the frog will not come out and boil itself to death.

Which means losses keeps on accumulating and the trader brings in more money and keeps loosing. Only to realize one day that his looses are running into lakhs. By this time it is too late to recover.

All these things happen because we never have a risk management plan in place. Well most do not even have a financial plan in place. Risk management is a small portion of your financial plan. Below I will try to address both.

How do you make sure that Risk is properly managed and you do not lose more than you can afford while trading?

Here are some steps that you need to take immediately if you want a sound financial future:

1. Do not bring more than 25% of your savings into your trading account. First of all why do you want to bring too much money into your trading account? To make more money? Well if you cannot be profitable in a small account how can you be profitable in a bigger account? In fact traders who are losing money should not bring any more money into their trading account. You will lose even more. First prove yourself that you can make more than 2% profits per month in a small account on an average for the last 10 months. Once you have crossed that threshold – you can bring more money every month. Keep a fixed amount to add to your trading account every month for a certain period. Because if you bring in a lot of money at once and take a stop loss in a big trade – you can lose a lot of money. But a fixed amount will ensure a small loss.

2. If you trade on a leverage you should always hedge your position. Future and Options both are traded on leverage because you only trade with 10-15% of the value of the trade. If you make money that is good, but if you lose you will lose on the value of the transaction not on the margin blocked. This is even more important if you are keeping the position overnight. Lets say you have Rs. 50,000 in your account and you bought 2 lots of Nifty future risking everything you have in your trading account and next day there is a gap down of 300 points.

I bet you will square off your position in panic. This is what you will lose then 300 * 50 * 2 = Rs. 30,000.00. This is 60% of your trading money. Do you think you will have enough courage to ever trade again?

But had you done some kind of hedging – like buying OTM puts I am sure you losses would have reduced to 20% of your money. This will leave you with some courage to trade again.

In stock markets always risk what you can afford. The money that you cannot afford to lose should be kept in fixed return instruments. Let the financial analysts say that Fixed instruments are boring and all that – the fact is they themselves are doing exactly opposite to what they are saying.

They have a job right? So they will say what looks good, but may not work as suggested. Which is better – losing money trading or putting money in an FD that generates 9% return every year for doing nothing?

Long back I had written an article on investment opportunities in India. It is highly recommended that you read that.

Here is how you should divide you savings. I believe in 25-25-25-25 rule.

(This is my belief – yours may differ – but I believe dividing money in different assets class. This will ensure less volatility in our financial portfolio.)

This is what I do (and you can do too):

25% of what you save should get into fixed return instruments guaranteed by Government of India. These are bank fixed deposits, post office schemes, EPF, PPF etc.

25% of what you save should get into diversified equity mutual funds. Select 3-4 different mutual funds based on their last 5 years performance. Invest only in 4 or 5 star rated funds by value research. These funds should be from different fund houses and their investing style should also be different. For example you can select one large cap fund, one mid cap fund, one small cap fund, and one thematic fund in a sector you believe in. Invest through SIP (Systematic Investment Plan to take advantage of averaging your cost of buying these funds). If possible invest in Direct plans to save money. Review every year to change any fund that is not performing.

I was surprised to know that most option traders do not invest in mutual funds. Why? They do not need your time and hard work. A very qualified fund manager works on your behalf. The fee they charge is also less – so why not make use of this great opportunity? Over a long period of time good mutual funds can generate 12-15% returns a year. Without any work I think it is a fantastic return.

25% of what you save should get into good large and mid-cap equities. Yes direct buying of stocks for long term. Here too buy systematically every week or month. Never buy any stock in bulk. If you have any stock that you want to sell, its better to start a covered call rather than direct selling. That way you will still make money if the stock does not reach your call strike price.

25% of what you save every month may come into your trading account. Since this is the most riskiest of all the above investments – you should have a limit to how much big your trading account should be. This will differ from person to person but you should know your limit here. Once that limit is reached – you know that it is the maximum you will lose if anything horrible happens. Once this limit is reached – do not bring any new money to your trading account. Just reinvest the profits and compound it. Compounding is magical and therefore you need not bring more money to it once the limit is reached.

One more thing – instead of putting surplus money in your bank you can put them in a liquid mutual fund. These funds generate 8-9% returns a year. This is much more than 3.5% Indian banks give as interest. Liquid funds have no entry or exit cost – so they are as good as any bank deposit. What’s more you can invest online and withdraw money to your bank account online.

Also if you are the head of the family and your family depends on you financially, you should always buy a term insurance policy. In case something happens to you – your family will get the sum assured and at least financially they will not be worried. Buying them online will be cheaper.

Of course now days everyone has a medical/health insurance. If you don’t have one – buy as soon as possible. Don’t forget to have a family floater plan that will cover all your family members. One major health issue to any family member can make a huge dent into your savings. Health insurance is a must.

As you can see I have not included real estate, gold and ULIPs in my investments. These are one of the most sought after investments in India. But I do not like them for the following reasons:

Real Estate: Will eat up a significant portion of your savings. If you have not timed your buy correctly or were not able to negotiate well, you will find it hard to find a buyer to sell in profits. Its a big investment – it carries a major portion of your savings so you will always be worried. (I hate worrying about money) Every month you will have to pay the mortgage, pay electricity bills, municipal taxes, clean the house etc. Repairs costs money too. Mortgage costs money. If you want to rent then finding a good family for renting is not an easy job. When they leave you will have to spend a lot on repairs, paintings etc.

People like us can invest in at most two houses. One where we live and another for investments. Investment in just one real estate is a hit or a miss thing. Either you make good money when you sell or you make average or even a loss. To make good profits you have to keep it for ten years at least. And if you make only 10% compounded annually minus your expenses, you made less than what a good mutual fund could have made without any work on your part. Not a smart choice in my view. If you want to invest in real estate just buy one property where you can live.

Here are more links about why real estate is a bad investment:

http://www.iwillteachyoutoberich.com/blog/surprising-real-estate-investing-myths/

http://www.cbsnews.com/news/history-says-home-real-estate-is-a-bad-investment/

http://www.myonemoney.com/inside-edge/money/278-why-owning-a-home-is-a-bad-investment–but-often-a-smart-decision

Gold: This is another investment I hate. Gold will never beat equity returns over a 10 year time frame. Still if you want to invest in Gold – you should invest in Gold ETF every month or do a SIP in a good Gold fund. Redeem them when your kids get married to buy gold and/or when you want to buy gold for any occasion.

ULIPs – Unit Linked Insurance Plans: Worst investment ever. Government of India should ban ULIPs. Even if markets give a return of 30% – ULIPs will only generate 10-15% or even a loss. Because its a costly investment. A major portion goes into buying insurance for the owner. Yes you may not get anything in return in a term insurance if you survive the term – but if something happens to you then ULIPs will not give your family the kind of money they need. It won’t solve any purpose. Moreover its market dependent. When it is redeemed and markets are down you may lose money. Keep your insurance and your investments separate and you should get better returns. ULIPs do not solve the purpose of either insurance or investments – so they should be avoided.

IMP: Every quarter you should count your worth. This will help you know your wealth and what you can expect from future. It will also tell you any mistakes you made in the past. This will help you to plan well. If you are strict with your finances, I assure you will only get richer with time.

Happy Investing and Wishing You the Best For Your Future!

Disclaimer: The views expressed in this article are of the author. Please do your own research before investing money in anything. This is the way I manage my finances and am comfortable. Your situation may be different. Therefore you may want to take a different approach. The only benefit of the above investment approach is that the finance portfolio is less volatile. However it is recommended that you do your own research before taking an investing decision. Do not take investment decision in a hurry.

If you have read my post on Long Call Butterfly, this trade will be easy for you to understand. Results for the Short Call Butterfly will be exactly opposite of the Long Call Butterfly.

Lets discuss the trade straight away.

When should you trade Short Call Butterfly?

You should trade this strategy when you think that Nifty will move away from the current strike and expire 100-200 points away on the either side – up or down does not matter.

Three trades are involved (note that these trades are exact opposite of the Long Call Butterfly):

1) Buy 2 lots ATM (at the money) Call Options
2) Sell 1 ITM (in the money) Call Option
3) Sell 1 OTM (out of the money) Call Option

Risk: Limited
Reward: Very Limited

Now lets take a real world example and what profit or loss the trader can make.

(Spot Nifty – 7905. Prices as of August 26, 2014 after markets closed. India VIX (Volatility) – 13.90 – Average. Taking September 2014 expiry as August expiry in 2 days. Option prices rounded off for clarity.)

1) 25-Sep-14 CE 7,900.00: 135.00

Buying 2 Lots = 135*50*2 = 13,500.00 (Debit from account)

2) 25-Sep-14 CE 7,800.00: 200.00

Selling 1 Lot = 200 * 50 * 1 = 10,000.00 (Credit into account)

3) 25-Sep-14 CE 8,000.00: 83.00

Selling 1 Lot = 83 * 50 * 1 = 4150.00 (Credit into account)

Total credit: 10,000 + 4150 – 13,500 = 650 (This is the maximum possible profit)

Total margin blocked: 62000 (approx)

ROI: (650/62000) * 100 = 1.04% in 30 days. In my view this is slightly better than a bank fixed deposit, and at par with many mutual funds. Any strategy that makes less than 2% in 30 days should not be traded. Trading is a business and returns should be attractive.

Return on investment is poor – in fact it is very poor. Such trades with low ROI and high risk are best avoided.

We will now see that risk-reward ratio in this trade is pathetic too – but success rate is good as there will be a movement in Nifty and near expiry if Nifty is away from the strike price of the bought calls – on either side, the trader can book his profits. But unfortunately one loss can take away months of profits. So lets try to find what happens if this trade is successful and what if not.

Lets take an example of when this trade is successful:

Nifty is exactly 200 points above bought call strike price of 7900: 7900 + 200 = 8100 on expiry day.

Calculations:

1) 7900 CE is 200: Profit: 200 – 135 = 65 * 50 * 2 = 6500
2) 7800 CE is 300: Loss: 200 – 300 = -100 * 50 * 1 = -5000
3) 8000 CE is 100: Loss: 100 – 83 = 17 * 50 = -850

Total profit: 6500-5000-850 = 650

Note that profit remains same if Nifty is above this anywhere.

Lets take an example of when this trade is successful on the down side:

Nifty is exactly 200 points below bought call strike price of 7900: 7900 – 200 = 7700 on expiry day.

1) 7900 CE is worthless: Loss: -13500
2) 7800 CE is also worthless: Profit: 10000
3) 8000 CE is also worthless: Profit: 4150

Total Profit: 10000 + 4150 – 13500 = 650

Note that if Nifty is anywhere below this on expiry day, the results will be same. The trader will make a small profit.

Now lets analyze the situations where the trader can make a loss.

Nifty is exactly on 7900 on expiry day – the strike price of the bought calls.

1) 7900 CE is worthless: Loss: -13500
2) 7800 CE is 100: Profit: 200 – 100 = 100 * 50 = 5000
3) 8000 CE is also worthless: Profit:: 4150

Total loss: 5000+4150-13500 = -4350

Nifty at 8000:

1) 7900 CE is 100: Loss: 135 – 100 = 35 * 50 * 2 = -3500
2) 7800 CE is 200: No Profit No Loss as it was 200 = 0
3) 8000 CE is worthless: Profit: 83 * 50 = 4150

Total Profit: 4150-3500 = 650

We have already calculated 8100 and above will be same.

Nifty at 7800:

1) 7900 CE is worthless: Loss: -13500
2) 7800 CE is also worthless: Profit: 10000
3) 8000 CE is also worthless: Profit: 4150

Total Profit: 10000 + 4150 – 13500 = 650

We have already calculated 7700 and below, the results will be same.

So what do you make out from this trade? This is one of the worst trades to try out. Agreed mostly you will make a profit, but one loss will take away nearly 7 months of profits (4350/650 = 6.7). I have not even added the brokerage to this profit of 650. 4+4 = 8 trades are involved to open and to close. Calculate yourself what kind of profits remains even if this trade is successful most of the times.

My advice: Stay away from such trades when risk-reward is pathetic and on top of that you may be hoping that Nifty is nowhere near the bought strike price during the expiry week.

How To Adjust A Short Call Butterfly:

This is also a set-and-forget trade. If you see profits (even a small one) on any day before expiry – it is advised that you close the trade because at any cost you should not take the maximum loss.

If you keep rolling over whenever Nifty comes near the bought calls strike – you will take a loss every time you do. Therefore rollover is not recommended.

You cannot wait till expiry as this trade can make a big loss on that day. Also you will not get good profits when Nifty is away from the bought calls strike price and expiry is not near. When you close it few days before expiry, you may make some money but that will be less than the max profit. On top of that, eight transaction will involve a lot of money in brokerage.

Therefore this is a trade better avoided.

Have you ever traded a Short Call Butterfly? I am eager to know the results.