I am sure you must have heard of Long Straddle. It is an aggressive option strategy where a trader buys both ATM Call and Put options to make use of a big movement that he anticipates in the stock in the next few days. (It is not necessary to buy ATM strikes only; basically if you buy both Call and Put of the same stock or Index and of the same strike and expiry – you are trading a Long Straddle.)

Long Guts is somewhat similar to Long Straddle, except here the traders buys 1 (or more lots) In The Money (ITM) Call options and same number of In The Money (ITM) Put options.

Construction of the Long Guts

Buy ITM Call Options
Buy ITM (same number of) Put Options

Risk is Limited and Reward is unlimited.

Please see the image below to understand better:

When to Trade Long Guts?

When you anticipate a big movement in either direction – up or down on any stock or Nifty in the near future. The reason can be anything. A big news like budget, quarterly results of a stock, mergers, company buying another company, security threats, company going bankrupt etc. Whenever such a big news is coming, usually there is a lot of trading and the stock moves in either direction sharply.

The trader profits if any of the option i.e. the Call or the Put exceeds the break even point of the trade. It is also important that Volatility also increases. Since both the options are very costly – Volatility has a major role to play in profit or losses in the Long Guts.

How to Trade Long Guts

Note: We will also see that Long Guts is cheaper than Long Straddle even though more money is required to trade this.

1. Calculate Your Max Loss:

Before placing the trade the trader should calculate the maximum loss on the trade. This is how to do it:

Getting real prices:

Feb 02,2015: Nifty is closed at 8800. The Volatility is 20.41.

The trader decides to buy ITM 8600 CE @ 327 and ITM 9000 PE @ 240.

Lets calculate this on one lot only as too much is at stake in this trade. Remember the trader buys In The Money options and they are very costly. This is a big problem with Long Guts. You may need a lot of money to trade this, but still its a better trade than the Long Straddle.

Note: I rarely see traders in India trading the Long Guts for this simple reason that this trade needs a lot of money to play. We are not comfortable putting too much money on risk. 🙂 But we forget – no pain no gain. 🙂

Is this trade really costly? Ok lets see how much money is on risk and also evaluate if more money is risk in this trade or the Long Straddle which is the favorite strategy among aggressive option traders in India:

Money at risk: (327+240) * 25 = Rs. 14,175 + Brokerage. Lets forget the brokerage for now.

However the best part is, this is NOT the trader’s maximum loss. The maximum loss occurs when Nifty is anywhere between the two strikes. Assuming Nifty is exactly at 8800 on the expiry day. Lets calculate the max loss:

8600 CE will be 200 and,
9000 PE will also be 200.
Loss on CE: 200-327 = -127
Loss on PE: 200-240 = -40
Total Loss: -127-40 = -167 * 25 = Rs. -4175.00. This is the max loss.

Now lets compare losses of a trader who traded a Long Straddle (he bought both the 8800 CE and PE)

8800 CE is @ 200
8800 PE is @ 140

If on the expiry day Nifty is at 8800 the trader will lose 100% of the money he used to trade this.

Total loss: -200-140 = -340 * 25 = Rs. -8500.00

Now tell which strategy is more costly? Its obvious that though more money is required to play the Long Guts, it is much cheaper strategy than Long Straddle. 🙂

However this is not the end of story. The trader now needs to calculate the break even points.

2. Calculate the Break Even Points:

Lets calculate the break even points:

327 + 240 = 567

BE For the Call side: 8600 + 567 = 9167
BE For the Put side: 9000 – 567 = 8433

So if on the expiry day Nifty is above 9167 or below 8433 – the trader makes a profit.

Now lets calculate and see the breakeven for someone who traded the Long Straddle the same day.

200+140 = 340

This was done on the 8800 strike.

BE For the Call side: 8800 + 340 = 9140
BE For the Put side: 8800 – 340 = 8460

As you can see there is not much of a difference between the break even points of Long Straddle and Long Guts, but money at risk is less in Long Guts. Therefore it makes sense to play Long Guts than the Long Straddle, if you have a Volatile view on Nifty.

However as expiry comes near the Long Straddle will perform better than Long Guts as they will need small movement to profit. These straddles are available at low rates in the expiry week. In fact you can try this on the expiry day as an expiry day trade. But please be careful – do not buy too many lots. If trying this as expiry day trade, please do not pay too much to trade this. If Nifty closes exactly at the strike where you bought your options; they may expire worthless and you may lose 100% of your investment in the Long Straddle. However this rarely happens. 🙂

3. Knowing the Strike Prices:

In a Long Guts it is very important to know the strike prices which you will buy. You have a problem here. If you go too deep – you will need to pay more. Agreed that max loss will decrease if you go deep into the money but the profit potential will decrease as well. Nifty will have to move significantly to profit. So the best strike prices are those that are slightly in the money.

This means if Nifty is at 8500, you can buy 8400 CE and 8600 PE or 8300 CE and 8700 PE. Maintaining same distance from current spot will make it a neutral non-directional trade. If you are closer to the Call side then it will benefit more if the stock goes up, similarly closer to the Put means it will make money fast if the Stock falls.

Ideally you should go same distance from the spot to select the strikes to keep it neutral.

Going any further than 1 or 2% will almost certainly decrease your chances of making a profit and you may need too much capital to trade. You will feel uncomfortable.

4. Idea of Volatility:

Volatility plays a major role in determining your profit or loss in Long Guts especially if you do not want to wait till expiry. Not waiting till expiry is almost always a good decision because you can always book profits whenever you are making 10 or more points which is 2% of the money blocked.

Who knows on expiry day the long guts will lose its maximum. But if you are OK with the max loss, you can wait till expiry. In my view people waiting till expiry are gambling, not trading. They will make loads of money in 1 trade, and lose it all the very next. And then start from scratch.

Long Guts will make money if there is a movement in one direction and/or Volatility increases. Therefore its very important that you have an idea of Volatility. Usually Volatility increases when there is a big news coming.

You can trade the Long Guts a few days before the news is pending and booking your profits before the news is out. Because if the news is out, Volatility will decrease and both the Call and Put options will lose a lot of their premium.

One example is General Budget. Right now VIX is increasing and I assume it will keep increasing till the Budget is out, end of Feb 2015. After that once the news is out, it will surely shrink.

Another example is when a company is going to declare its quarterly results. You can get in 10-12 days before the results day and get out 1 day before the company announces its results.

Note: Of course if you want to wait till expiry then Volatility is not important. On the expiry day options will have only the intrinsic values. Time and Volatility in the premium will be zero.

5. How to Lock-in Your Profits:

One option will surely increase in value when the Stock moves. Supposing it went down. Now you may feel that people may start buying the stock and it may reverse. So the money you made in the Put option may go. In that case you can either sell the Put option you bought to book profits, or Sell another strike Put option that has increased in value.

For example in our example Nifty was at 8800 when you bought the ITM 9000 PE @ 240 and now Nifty is at 8750, you can sell the 8600 PE at 82 and lock the profits.

Now if Nifty reverses and starts to move up you will lose money from the PE buy, but make money from the PE sell (essentially locking the profits you made from the Put option), and the Call buy. Once you are making reasonable profits from all three trades you can exit.

However please be reminded that this thing is a bit tricky. If Nifty keeps moving down, any more profits coming from the PE buy will be capped and both the PE sell and the CE buy will lose money. So please do your math before taking this step. However it will work wonders if Nifty is range bound. If the newly sold options expires worthless, it will far exceed the losses made from the bought options. 🙂

Therefore you should lock in the profits only when the options have crossed the Break Even points.

Conclusion:

• Long Guts is a trade where the trader has a Volatile view on the stock.
• It is played by buying the In The Money Call and Put options.
• The trader benefits if there is movement in either direction up or down and Volatility also increases.
• Its better to take profits out before expiry because on expiry day the stock may reverse and finish exactly where it started and the trade may lose its maximum.
• Long Guts are better than the Long Straddle because the max loss is a lot less, however the profit potential is almost same.
• However this trade cannot be compounded as too much money is at risk.

If you trade Long Straddle, after reading this article will you start trading the Long Guts? Please let me know in the comments.

Calendar Spread is a slightly complex but an interesting options strategy. When I will discuss it, you will think its a great strategy which will almost always result in profits. But in reality it is not the case. Yes it can make great profits but one needs some skills to excel in this strategy.

It is also called as Neutral Calendar Spread because the traders view is neutral on the market or the stock over the next few days or till the expiry of the sold options. However we will see that volatility also has a major role to play in Calendar Spreads.

When To Trade Calendar Spreads:

When your view is Neutral on the stock but you feel Volatility will increase in future. This means you expect not much movement over the next few days on the stock or the index.

Risk is Limited (But cannot be defined or calculated before the trade is made)

Reward is also Limited (This too is unknown; exact profit is known when the trade is closed)

How To Trade Calendar Spreads:

1) Sell 1 Lot Current Month Option
2) Buy 1 Lot Next Month’s (or any months option expiring after the options that were sold)

For a true Calendar Spread both options sold and buy should be of the same strike price. If you change the strike prices they are known as Diagonal Calendar Spreads which I will discuss some other day.

Look at the image below. For now keep in mind that Calendar Spreads has a max profit point we discuss later. There is a sag otherwise. The max profit can be attained only on the expiry day.

The trader has to pay money to trade Calendar Spread. This is because the options that are bought are costlier than the options that are sold because the bought options expire later. If you know about Option Greeks, you may know it is because these options have more time value (Theta) therefore they are priced higher.

Now I think you can guess why the trader sells current months options and buys next months options. If not please read the following paragraph to understand this better:

Suppose a trader sells current month’s At The Money (ATM) options expiring in 20 days and buys next months At The Money options expiring in 50 days. Basically his view is this: if the stock remains here for the next 20 days – the ATM option that he sold will expire worthless, but, the options that he bought will still have 30 days time to expire – therefore it should retain a lot of value (though less than what it was 20 days back).

So the profit from the sold options should be more from the loss of theta from the options that were bought. If the profits from the sold options exceeds the losses from the bought options – the trader keeps the difference.

Simple right? No. We will soon know its not that simple. 🙂

I hope why this trade is made is clear. It is to profit from the difference of Theta (time value) of the current month sold options vs. the next months bought options. The current month option will expire before the next month options, and the trader can profit.

This looks like an easy trade. Let me warn you. It is not. It only looks easy.

Why it looks easy is that the trader thinks that if Nifty goes against the sold options, the bought options will increase in value and save him from unlimited losses (true but he still loses money though limited), and of course if it falls the speed of the profit from the current month options will exceed the loss from the bought options (true and false – because it depends a lot on Volatility and movement of the stock).

Interestingly the above would have been true had the option Greeks remained same for the next few days and the stock remains in tight range. Option Greeks especially Volatility plays a major part in deciding what happens to these options; and this is where traders fail. 😉

I will discuss how you can benefit from this as well.

Lets discuss how to trade Calendar Spreads in the best possible way:

1) Sale vs. Buy: There is no need to buy next months options. Yes liquidity is an issue in India, but in the US many traders sell 10-15% up/down current month’s options and buy 10-15% up/down options expiring in say next 6 months. They sometimes do it in both Calls and Puts – thus making it a Double Calendar Spread.

Yes they pay good cash to trade this – but they also get amazing protection. If the stock does not go near the short options – they keep eating the premium for the next 5 months. Which means they keep on selling the next month’s options as soon as the current months expire – same strike. As you can see some months they make good money from the sold call and some month from the put depending on the stocks’ position.

Thus by the time they reach the month in which the options were bought – they may already be in good profit. Now they can just keep these options as an open free trade of long strangle to look for a quick opportunity to make good profit either side. Remember this option has already been paid off and the trader is at zero risk to keep this till expiry. Even if he sells this at break even – he makes good money.

In India this may not be possible now but who knows what may happen in the next few years. The liquidity in options are increasing every month. So right now you have no other option but to buy next months’ options.

2) Time vs. Volatility: This is a very important point. Assuming you sold an option 200 points up in Nifty current month and bought a next month’s option same strike. 30 days are remaining for expiry.

This is your trade (Real prices as on 29-Jan-5015. Example on 4 lots or 100 shares):

Spot Nifty: 8890
India VIX (Volatility): 20.02 (Now that we have a major event next month – Budget 2015 – I assume volatility will keep rising till that day and crunch the next day when the news is out.)

Sell 100 NIFTY FEB 2015 9100 CE @ 112
Buy 100 NIFTY MAR 2015 9100 CE @ 230

Total debit: 230-112 = 118*100 = Rs. 11,800.00

Now lets discuss the best possible situation. On expiry day of sold options (26-Feb-2015) Nifty is at 9090.

The sold option will expire worthless. The trader keeps 112*100 = Rs. 11,200. But depending on the Volatility (repeat that again – depending on the Volatility on that day) the price of NIFTY MAR 2015 9100 CE can be:

a) The same – Volatility has increased so Time value (Theta) did not have much effect on the option plus Nifty also moved up 200 points. Now 9100 is ATM option – when the trade was done it was out of money.

b) More than 230 – Volatility has exploded, increased too much, so much so that it surpassed the option premium eaten by the time value. This is best possible situation for the trader. He profits from both months’ options. Profit from Feb and Profit from March. This is the max profit zone as in the image above. Or,

c) Is less than 230 – most possible scenario. Volatility remained the same or decreased. Depending on the loss on this option the trader makes a profit or a loss. If this option is less than 119 (230-112) on the expiry day the trader will lose money.

There is more to it. We have assumed that Nifty is at 9090 on expiry day just below the sold option strike. But that may not be true. It can be at 8500 or 9500 on that day. And Volatility too is unknown to the trader. We really do not know where Nifty and Volatility will be on expiry day.

Hope you understand now. This is not as easy as it sounds.

How Professionals Play Calendar Spreads?

For them it is more a Volatility play than anything else. For example if they sense Volatility is going to increase for the next few days – they trade the Calendar Spread – mostly on the ATM options. Since Volatility affects ATM options more than any other option – they make quick profit in a few days time and get out of the trade. They do not wait till expiry like an amateur trader looking to profit from the best possible situation on expiry day, that rarely happens. 🙂

3) Can be done on Futures too: Neutral Calendar Spreads can be done on Futures too. We all know that Futures carry a premium. This premium gets to zero on expiry day.

For example Nifty is at 8890; NIFTY FEB 2015 Future is at 8945 and NIFTY MAR 2015 Future is at 9000 (real prices as on 29-Jan-2015). The difference is 9000-8945 = 55 points. If you think on the Feb expiry day this difference will increase you can sell Feb Futures and buy March Futures.

Say on expiry day Nifty is at 8900. Then Feb Future will be at 8900 and lets assume you were right and March Future is at 8970. So your profits from Feb Future: 8945-8900 = 45. Loss from March Future: 8970 -9000 = -30. Difference = 45-30 = 15 Points profit. Or 8970-8900 = 70 – 55 = 15. If the difference is less than 55 points you will lose money.

Of course you can do vice-versa if you think the difference will decrease. Then Buy Feb Futures and Sell March Futures. This is known as Reverse Calendar Spread. It is more common among professionals and institutional investors because full margin is blocked. (We will soon know the margin requirements on Calendar Spreads.)

Reverse Calendar Spread works exactly opposite to Calendar Spreads. If Volatility drops – Reverse Calendar Spreads usually profit. Because profits from the sold options are more than the loss from the bought options.

Just a note on margin requirements on Calendar Spreads. NSE recognizes Calendar Spreads on Futures. You can read in details here.

Here is the abstract from NSE website:

Calendar Spread Margin: Contracts where futures position at one maturity is hedged by an offsetting futures position at a different maturity would be treated as a calendar spread. The calendar spread margin shall be charged in addition to worst-scenario loss of the portfolio.

If done on Futures your broker should block only the maximum loss. For example in the above case its 55 points. Because you lose only if the difference is less than 55 points. Max loss is 55 points (which is very rare).

On options unfortunately NSE does not recognize Calendar Spread as a limited loss strategy therefore full margin will be blocked for selling options. Please ask your broker for more information.

Note: Calendar Spreads are actually traded on points difference only on NSE as a single trade. You need not buy one Future and Sell another. You can just sell the Calendar Spread at 55 points and buy it back whenever it comes in profit or on expiry day.

Margin blocked for one lot will be 55*25 = Rs. 1375 + brokerage. That way even if you make 10 points on this, its a great profit. 25*10 = (250/1375) * 100 = 18.18% return in 30 days or less just on 10 points. But please do not attempt just based on what is written here – if the difference is less than 55 on expiry, you will lose money. Please consult your broker for more details.

A Calendar Spread on Nifty Future is traded like this:

If you think the difference will be less than 55 on FEB expiry. You can sell the Calendar Spread and buy it back for a profit later. Or if you think it will increase you can buy the spread and sell later. In this trade real Futures are NOT bought or sold. Its a bet between two persons. One of them wins other losses. Since there are just two trades you pay less brokerage. However STT is calculated just like its done on a Future trade so that still remains an issue.

Hope I am able to help you understand that Calendar Spreads are more complex than what most of us think about. Its more of a professionals’ trade than a retailers’. If you still want to try please try on one lot only.

Conclusion:

• Neutral Calendar Spreads are trade where the trader sells current month’s options and buys next months’ options. It is done on same strike.
• Calendar Spreads are done when the trader thinks Volatility will increase in the near future.
• Reverse Calendar Spreads behave exactly opposite of Calendar Spreads. This is done by professionals when they think Volatility will decrease.
• Can be done on Futures. On Nifty Futures the Calendar Spreads are actually traded. You need not sell one Future and Buy another – you can accomplish this in a single trade. Margin blocked will be the max loss or the points being traded at that time.

I am sure many of you have traded Neutral Calendar Spreads. If yes tell me do you wait till expiry or book your profits or losses within a specified time/points?

We will discuss if Technical Analysis – trades based on indicators in stock markets does make money or not.

My view on Technical Analysis / Disclaimer:

I do not have much knowledge in Technical Analysis (TA) neither there is a need to learn because I am very happy with my conservative trading strategies. TA is for people who want to be very aggressive 🙂 – those who want astronomical returns from stock markets. Very few people are able to do it. People like us who are retail traders with a job or business should look for small consistent profits.

Technical Analysis traders take short-term naked directional trades. This is big risk. If you have a job, this gets very difficult as you need to keep an eye on your trades every second. You must be able to quickly take profits or losses as per the indicators. These trades needs 100% of your attention. If your trading account is large and/or you are trading hundreds of lots, you cannot leave your trading table without stop-loss in your system for even 10 minutes.

Traders using Technical Analysis either go for buy or sell mostly using Futures as per the signals of their program. Some of them use options too. Since they love to trade direction, Futures are mostly preferred. Most of these people use some kind of tools/software to help them know the indicators to buy/sell. Some buy it from third parties, some develop their own trading ideas using Technical Analysis software available in the market. But frankly what a human brain can do, software cannot do because they do not have the ability to think.

Technical guys rarely trade next month derivatives. Some quickly get in or get out in few minutes or hours. Some in 2 or 3 days max. Some even develop systems to do automated trading / algorithmic trading.

In automated trading the system takes care of trading. The trader just needs to give information. The rest is taken care of by the system. This has its pros and cons. Human emotions of fear/greed are totally out of the trading system – this is a positive. The negative is that if the system is not fed properly or if there is a bug (server/internet) while trade is on – a lot of problems may occur. Read this $440m mistake of automated high-frequency trading. One mistake in a software can take you down ages never to recover.

Automated or not – the decision the trader takes is the final one that decides profits or loss.

Technical Analysis is meant for small swings in a stock/index and it mostly comes in 2-3 trading sessions. In fact if target is not hit, as far as I know they close the trade as they hate taking long positional trades. 3-5 trading sessions is the most they can wait. Most of them then start looking for new indicators. Why? Because for them time is money and any movement is what they want to capitalize on. Of course this is not possible always.

For example their software my not generate any signal for a day – they will still trade because they think they control the system – and not the other way round. Basically they get bored if they are not trading. My apologies if I am wrong but the new entrants to TA think they are better than normal retail traders. Of course they realize their mistake when they lose a lot of money (and time) trading. 🙂

Only a few go for positional trades. They either make a lot of money from one trade or lose a lot due to un-hedged directional trades. So technical analysis is for people who can take big risks. I am not one of them. This does not mean I am against Technical Analysis – I am only saying you should have a huge appetite for risk if Technical Analysis is what you are looking for to implement in your trades. And yes if you have a job or are into a business you will have a lot of difficulty doing trades based on technical analysis. They need your time.

A few traders may even hedge – but technically its not technical analysis. In my view they are better traders.

Some of the things they learn are: Line Chart, Candlesticks Chart (very popular), Bollinger Bands, Dow Theory, Support & Resistance, Fibonacci Retracements, Japanese Candlesticks, Trend Reversals, RSI, Stochastics, MACD, ADX etc. (Does it not sound like an Engineering Course? 🙂 )

I also think that if Technical Analysis really made huge money (reasonable for a living every month from an average trading account of say 5 lakhs) why would people struggle, pay and work hard for 4 years to study Engineering/Software/Medical/CA/Law etc? They would rather invest a year or two studying Technical Analysis and make money from home. Logical?

Making money from home is always better than taking a job, right? Why not every intelligent person is a TA?

I don’t know but maybe some guys are really good at it and are making a killing using TA. But they must have great methods. The real picture is, for most, Technical Analysis does not make money. And this I am saying after talking to at least 25 traders who are doing Technical Analysis in stock markets. 100% of them lost money using TA.

Social Science Research Network – a research company based in US, did a research on individual traders doing Technical Analysis and found that most traders doing TA lost money. Here is the link:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2401230

If you want to download the research report you can download it here.

Here is the abstract:

We find that individual investors who use technical analysis and trade options frequently make poor portfolio decisions, resulting in dramatically lower returns than other investors. The data on which this claim is based consists of transaction records and matched survey responses of a sample of Dutch discount brokerage clients for the period 2000-2006. Overall, our results indicate that individual investors who report using technical analysis are disproportionately prone to have speculation on short-term stock-market developments as their primary investment objective, hold more concentrated portfolios which they turn over at a higher rate, are less inclined to bet on reversals, choose risk exposures featuring a higher ratio of unsystematic risk to total risk, engage in more options trading, and earn lower returns.

One day I got this email from Mr. Shantanu – an expert in Technical Analysis who is a regular visitor to this website.

Hey Dilip,

Big fan of your website. I am someone who lost a fortune and made a fortune in last 7 years of my trading. I used to bet just like others in the market, got whooped. But today, I can actually claim to be one of the finest technical analysts the world ever saw :). Alright…just a rookie with 4 years exp in chart readings. I love the way you present trading psychology. But the learning we gain from your website on the finer parts of option trading is awesome. Will surely go for your course, not for making money, but to be rich with knowledge 🙂

Regards,
Shantanu

I was very happy to receive this letter as it came from someone actually making money using TA.

So to know the answer I asked Shantanu if he could write about pros and cons of technical analysis and let my readers know if they should invest in Technical Analysis knowledge. I asked him if he could throw some light on this issue and let us know if someone can actually make a decent living out of Technical Analysis. Please read my notes in between too.

Here is Shantanu’s reply:

Yes, we can make a decent amount of money with knowledge of technical as it is also a tool that helps to get out at the right time when the tide turns against you (hence gives Capital Protection). I have always believed that in trading, making money is easy, but not loosing money is an art. Coming to option trading, I never hedge, I know surprising, but true (that’s the confidence and trust TA gives me).

(Note: I told you these guys NEVER hedge 🙂 )

I believe its the language of the markets, it shows the true picture of greed and fear, everyday, every moment. You will be amazed, market is like a woman, and using TA, one can clearly understand when she wants to dance with you, when she wants you to stay away, when it lies…and when it is joking around :)…best part…I have charts to show all her moods 🙂

(Note: Yes charts are what has happened, NOT what is going to happen. Charts are history NOT future. I think more than the Charts these guys are very disciplined. They always take more profits than losses. For example if Charts are showing Nifty will move up and its at 8200; they will take their profits at 8300 – or let the profits run till it lasts, but stop loss at 8150. That way if they are 50% of the times correct they still make money 🙂 . Anyone with TA knowledge please throw some more light on this. If I am wrong please correct me.)

TA or not if you are taking directional trades you should take double the profits than your losses. You will see that you are making money over time – but you have to be right 50% of the time. 🙂

Alright, so some positives and negatives of TA:

Positives:

1- Gives a trader eyes and ears on the behavior of the market.
2 – Helps you understand the most important of trading, Price Action.
3 – Answers you Why, What, and When. Basically tells a trader, What it will do, Why it do, and When it will do it.
4 – Helps cuts down on losses.
5 – Helps people to stay on right side of the trend and allows a trader to let the profits run.
6 – Cuts out emotions and egos from trades.

(Note: 5th and 6th points are most important. They go with the trend until it lasts / or till their indicator’s target price. On the other hand they get wiped out by whipsaws (markets opening gap down/up in opposite direction the next day). Discipline is where they cut out emotions. )

Negatives:

1 – Not a perfect world so at times one can get deceived and take wrong positions (for example, today, most of the folks including me took a bullet).
(Note: Nifty opened gap down more than 1.2%)
2 – Half knowledge or poor knowledge can prove costly. Some people say TA is a smart way to loose money, those monkeys belong to this category.
3 – Can be overwhelming at times, people can get stuck with analysis paralysis and miss opportunities for entries and exit.

(Note:
1 – on that day Nifty gaped down more than 100 points. Gone – 100 points gone in 1 trading session. Now climb the ladder again. This is the major issue with TA.
2 – is a very valid point. If you just read a book on TA and think you are ready to take large bets – I bet you will lose ALL your money. Practice and perfect yourself if you really want to do well in Technical Analysis.
3 – is also very important. These guys like action. They get bored if they are proved wrong or Markets are not behaving the way they want it to behave or just not moving. Like I said they will wait for 3-5 days and start getting jittery if nothing is happening. Then they start looking for new opportunities.)

I have a simple system that I have developed (took me 3 years to make it) that generates signals which are good enough to make a living and take couple of vacations around the globe. My daughter had cancer when she was 6 months old. Treatment drained me of my bank balance, sold everything I had. Trading made me pay the bills, recover my money, and saved my kid.

(Note: If this is true Shantanu you have done a great job. Congrats. Not many people can develop a system that can give true indicator of market movement in short-term. May your kid have a long & healthy life.)

My system is very simple, however, there is a even simpler system that beats them all. Its called “Trendline Break Trading“. If you know how to draw a line, you can make money.

Setup in brief: Draw trendline of current trend (join minimum two points). Wait for prices to break the trendline (up or down) and wait for ADX (Average Directional Index) to confirm the same. That’s it.

My actual system gives more accurate trades as it removes market noise. But the above setup is used by me over any other system (sometimes I use this system even without the ADX, less oscillators the better, trust your eye). Backtest it yourself, over any period, any instrument.

Thanks,
Shantanu

This is the image he sent:

Then I mailed him: Saw your image Shantanu. But it was made AFTER the event was over. How can you predict the future with that?

Shantanu’s reply:

Naah, we are not predicting but following the trend (only on this setup). Entry is on second candle, price should be near to closing of previous candle that broke the trend. So for example if Nifty broke the uptrend and closing price is 8500, our entry for short would be around this price the following day. I will try and send a more clear picture.

Still awaiting Shantanu’s reply. If you are reading this Shantanu please do write more about this in the comments section.

Conclusion:

• Technical Analysis is trades done for short period of times.
• TA are directional trades. Mostly done with futures with no hedged trades.
• Strict profit and loss laws are followed.
• Trades based on indicators/system/software.
• Human emotions are not involved.
• Not everyone can be a good Technical Analyst.

Finer Points:

• TA or normal speculative trades – the story is same everywhere. Most traders lose money. 🙁
• The real reason is trading more than the risk they can take, not hedging positions and speculating too much. And every-time they think that this time markets will behave the way they want. This happens once in ten times. This makes them confident and they trade again and lose more than they made.
• Not taking a stop-loss. Maybe ego or hope being a reason.
• You may or may not learn technical analysis but you should learn being conservative. Always hedge your positions, know your max loss, take a stop-loss or profits when a target is hit. Learn from your past experiences.
• If you do the same trade over and over again and expect a different result every time – you will lose money every time. 🙂
• Trading, as a profession, gets little respect. No one would try to become a doctor or lawyer without any training, but some traders just don’t think any knowledge is important. They speculate and lose a life time of earnings. I hope you are not one of them.

Are you a Technical Analysts? If yes please post over view on TA in the comments. We all will be thankful to you.

In the USA (United States of America) the short call ladder trade is popularly called as Call Backspread Trade. After my article on the short call ladder, I got an email from one of my regular website visitors, Mr. Michael from the US. We exchanged some questions and answers on this trade.

Call Backspread, I assume has a lot of interest to new option traders looking to make unlimited income by paying the least amount of money. We will soon know this is not the case.

Since the discussion was detailed and advanced I have kept this in a different article. This may be of interest to people looking for more information on the Call Backspread trade or the short call ladder.

If you are one of those traders who buy more OTM options and sell less number of near the money options to reduce cost as a single trade, knowingly or unknowingly you are trading the backspread. This discussion maybe of interest to you.

New traders who lost money buying naked options, think Call Backspread is a God send trade, a boon for cheap option buyers. They of course get disappointed.

Please note that the Call Backspread behaves the same way and produces similar results as the Put Backspread or the Short Put Ladder (if you are bearish). Needless to say please draw your own conclusion when you trade the Put Backspread or the Short Put Ladder.

What is a Call Backspread Trade?

In a Call Backspread trade the trader has a bullish view in the stock, but he/she is not willing to risk too much money by just buying costly ATM naked call options which may produce stellar returns if the view is correct. However if wrong, the trader knows he has a lot to lose. In fact the option may expire worthless, and all his money can be lost.

To reduce this risk he sells some in the money (ITM) calls and buys more number of ATM (at the money) or OTM (out of the money) call options. Essentially the trader feels that he will take the ride for free if the stock actually rises. In reality that is not the case.

(In the image above the trader has got a credit to do Call Backspread. See how the stock first has to travel through the loss zone to the profit zone. Only when a rally comes it goes into the profit zone. A trader may not have patience to wait that longer to take the “unlimited profits” lure this trade has.)

Most common trade is to sell 1 Call option and buy 2. Which means the trader sells 1 ITM option and buys 2 ATM/OTM options. This trade can result in a debit or a credit. If the options bought are further out of the money – the trade can be done on a credit.

But DO NOT think that if there is a credit the trader cannot lose money. There is always a trade off in these trades. In this discussion a lot of your doubts on Call Backspread will be cleared.

Lets gets started.

Michael’s email:

I just read through your E-book of the breakdown and discussion of the different options strategies. A fantastic and thorough explanation of the various option strategies.

I wanted to please ask you for your insight into trading Call and Put option “Backspreads” as these seem to be very directional type of strategy.

My thinking is, instead of doing a vertical debit spread, where upside profit is capped and also, buying regular long calls and puts for a directional trade, The Backspread seems ideal for this as:

1. You have the same flexibility in selecting strikes that fit your profit to risk threshold, but you get the added benefit with the Backspread over the Vertical, because your upside isn’t capped and you therefore have “unlimited profit potential”.

2. You can even make a credit, if the Backspread is initiated for one, if the trade goes below the sold Call for example, if doing a Bullish Backspread trade (it basically then becomes a Bear Call trade at that point).

3. You have the option of altering your ratio of bought to sold, depending on just how strongly you feel that the trade will make a big move.

4. On the high dollar priced, as well as volatile stocks like GOOG (Google Inc.), CMG (Chipotle Mexican Grill, Inc.), PCLN (Priceline Group Inc.), ICPT (Intercept Pharmaceuticals Inc.), BIIB (Biogen Idec Inc.), SPY (SPDR S&P 500 ETF Trust) – buying the outright calls and puts on these can be quite expensive, especially if buying 60 – 90 days out till expiration.

So by using a Backspread, we are in a sense doing a Vertical spread, of which we can play these higher dollar / more Volatile stocks at a discount.

I know that you are very knowledgeable about the strategies (Backspread) so just wanted to get your opinion on trading them, and if you had any thing specific, that I need to understand before implementing this strategy.

Thanks so much for your time and sharing your knowledge.
I really appreciate it.

P.S: How much and how would I go about purchasing your course please, as I live in the USA?

Thanks Again.

Michael

My reply:

>> 1. You have the same flexibility in selecting strikes that fit your profit to risk threshold, but you get the added benefit with the Backspread over the Vertical, because your upside isn’t capped and you therefore have “unlimited profit potential”.

This is true. But where do you book profits? Be honest when you answer this question. In my view there are a few choices:

a) Leave till expiry. Not good choice for any option trade in the world. A profitable position may get into loss.

b) Set a target. Good but difficult as volatility will be a big player. Plus when the stock is moving up you will get greedy for more. Remember the money is there to take and its unlimited. You may want to ride this as much as possible only to see you got less than you wanted.

You will NEVER be satisfied with whatever you make especially if the stock finishes up further on the expiry day. Still setting a target is a good idea. Buy you should exit once its reached and not look back at the trade.

c) As soon as ATM/OTM bought options becomes ITM. (Not sure if at that time the trade is profitable.) This will be tricky as at that time the trade may be in profit or loss. So even this choice is not good.

That leaves us with (b) – set a target and exit. But this target has to be with losses as well. If you read my article on short call ladder you will see that maximum loss is unbearable. You have to make sure it does not happen. So you have no option but to set a target.

Now tell me what is the difference between this trade and buying less number of naked ATM call options? You can always set a target even when you buy an option and exit for a set profit or a loss. Agreed if the stock falls below the shorted option and if the Call Backspread was done for a credit the trader may make a small profit.

But to create such a trade you will have to buy options far out of the money. For option buyers this is not recommended because realizing a good profit when the stock rallies will get difficult. You may therefore most of the times trade this with a debit. So you lose money even if the stock falls.

Moreover the stock will not fall every time you trade. Therefore to me this is not a better trade than a simple Call Debit Spread. If my view is bullish, I would rather trade a Debit Spread than a Call Backspread for the simple reason that risk in a debit spread is far better than a Call Backspread. Reward may be better in a backspread trade, but for me risk is more important than reward. Call Backspread only looks better on paper – in reality it is not.

Michael:

So would always entering a Backspread trade, be best by entering with 1 sold ITM and buying 3 – 4 OTM, for the sole purpose of being able to take profits once certain targets are hit, and still having the trade covered via having more bought Calls then sold Calls?

I know that by doing so, that we likely wouldn’t receive a credit for putting on the trade (and may be even a small Debit), but by using a 3-4 bought for 1 sold, we give ourselves the opportunity to lock in and take profits, if and when the trade exceeds the upper Breakeven?

My reply:

As long as you are getting a credit – or trading with a small debit – this is OK. But remember doing this with great strike prices may be difficult. You may have to go deep ITM sell and deep OTM buy – not good.

Also you need to calculate max loss – this is the place where the stock expires where all the options bought expires worthless and you also need to pay money to cover the short. This situation will be worse than buying naked call options. This means even if you have a credit, it does not mean you cannot lose money.

Michael:

>> 2. You can even make a credit, if the Backspread is initiated for one, if the trade goes below the sold Call for example, if doing a Bullish Backspread trade (it basically then becomes a Bear Call trade at that point)

My reply:

This is true but you may have to buy deep OTM calls. In that case even if the stock moves in correct direction your target may get difficult to achieve.

Michael:

Great point, and I guess this also gets back to the last question, to be able to buy at a higher ratio of long calls to short ( 3 – 4 : 1 ), we’d likely have to buy further OTM or sell deeper ITM, to cover the extra 1 to 2 Long calls.

Would it then come down to, whether or not we are fine with NOT receiving a credit for initiating the Trade?

My reply:

The problem with such a trade is that the stock has to move significantly for the deep OTM calls to make meaningful gains. Remember that the delta of the short is more than the delta of longs. So one the one hand your short will be loosing money fast, one the other the bought Calls will make money slowly.

However try to trade the best options possible and make sure you are NOT paying a lot of cash to trade this. Small debit is OK.

Michael:

>>It seems that, we would put on a BackSpread trade, if we had a strong conviction, that the stock was going to make a BIG move.

So my thinking is, would it make sense then, to put on more Long calls and thus give up receiving a credit, to allow ourselves the opportunity to have on the extra 1 or 2 long calls, to lock in profits along the way, if/as the trade makes that BIG move we were expecting?

My reply:

Yes true – but how many times will this happen? Do you think every time you expect a big move – the stock will actually move that big? If not your cash will be lost. Over time this will neutralize the results. Sometimes great – sometimes not so great. Consistency will be lacking.

Michael:

>> 3. You have the option of altering your Ratio of bought to sold, depending on just how strongly you feel that the trade will make a Big move.

My reply:

Yes true – keep changing your view and keep losing money when you were too bullish. And make less when you were less bullish. 🙂 Markets won’t behave the way you want them too.

Michael:

>> 4. On the high dollar priced, as well as volatile stocks like GOOG, CMG, PCLN, ICPT, BIIB, SPY buying the outright calls and puts on these can be quite expensive, especially if buying 60 – 90 days out till expiration. So by using a Backspread, we are in a sense doing a Vertical spread, of which we can play these higher dollar or more Volatile stocks at a discount.

My reply:

Options are priced in such a way that doing Backspread for 60-90 days options will surely cost you money. Its not easy to go that far, get great strike prices, and still get a credit.

Michael:

>>So the BackSpread then works like buying a regular Long and Put works. The more time to Expiration, the more expensive the Options.

My reply:

Now at last, Thank God you understood. 🙂

Michael:

>> How many days to Expiration then, do you usually look to go out, as to allow yourself enough time for the trade to make the move you are expecting – 30, 45, 60, 75, 90 days?

My reply:

See in this trade you are mostly long calls. Going very far or short in number of days is NOT important. Your view on the stock and Max loss that you may face is. Please calculate your max loss when trading this. Agreed if you stop out earlier, you will not lose the max loss – but its an important number to know before you trade. This is the reason why you shouldn’t pay a lot to trade this. Small debit is OK. That way if the stock falls, you don’t lose much.

Michael:

>> And does the time to Expiration come into play, depending on what time frame chart you are basing the trade itself on?

For instance, on a 1 Day chart, may be buy 30 – 45 days till Exp.
On a Weekly chart, go with around 60 days till Exp.
On a Monthly chart, 75 – 90 days?

My Reply:

As I said – plan before you trade. See if your Max loss (unfortunately profit cannot be calculated) justifies the trade. If there is a Max loss you are NOT comfortable with – either you should not trade or you should have a stop loss in your system. For profit taking too – you should know how much profit you want from the trade. Unlimited is only on paper, until you take it.

I think in US you can have a stop loss in system which is called Good ‘Til Canceled (GTC). This feature is not here in India. Make best use of GTC. Or monitor your trades closely to take profit/loss out at a predetermined value.

Remember this – you basically want to make unlimited profits, by paying the least. The idea is right, the implementation difficult. My only problem is unlimited profits is on paper. When the stock moves in your direction depending on how many options you bought and sold you may be making less because of the losses in the sold option, and you may want to wait.

Usually this will bring good profits when expiry is near. You may want to wait for expiry and then the stock reverses. 🙂 In panic you may stop out earlier. You cannot time this as the way you think you can.

Another very important point is Backspreads usually makes profit after traveling from the negative zone to the positive. Read this article to know more on this:

http://www.theoptioncourse.com/trade-short-call-ladder/

Michael, Many Thanks for asking some genuine questions on Call Backspread. This will help a lot of traders.

Short Put Ladder is exactly opposite of Short Call Ladder. In the Short Put Ladder Put options are traded instead of the Call options.

Note: This is the last series on the Ladder trades. A lot of traders whom I have talked to trade the ladder trade without knowing they are actually trading ladders. Most of them sell more and buy less options which means they are trading the Long Ladder unknowingly. Unfortunately most of them are speculating to their comfort and obviously losing money.

It always helps to know what you are trading and why? So if you are one of those who differentiate between the number of lots for buying and selling depending on your view, you are likely to do the same mistake again and again. Because every time you trade you will choose strike prices according to your convenience and not the correct strike for maximizing profits and minimizing losses.

If you differ the number of lots while selling and buying I request you to read all the four types of Ladder trades to help to understand which one to trade according to your view. Please get out as soon as your profit target or stop loss target is met. Hoping for a favorable outcome in every trade is not a good way to trade. Here are the link to the four ladder trades:

1. Long Call Ladder
2. Long Put Ladder
3. Short Call Ladder
4. Short Put Ladder – you are currently reading this.

The view: In a Short Call Ladder a trader was bullish, since they are opposite trades the view should be also opposite. In Short Put Ladder the trader is bearish. However in both the trades the trader’s view on volatility should be bullish.

So when you are bearish on a stock or index and bullish on volatility you can trade a Short Put Ladder. You have to be bullish on volatility because you are buying more options than selling. Volatility helps the buyers.

Risk: Limited
Reward: Unlimited

Construction of the Short Put Ladder Trade:

1. Sell 1 In The Money (ITM) Option
2. Buy 1 At The Money (ATM) Option
3. Buy 1 Out of The Money (OTM) Option

Have a Look at the graph:

Note: In the above image the trader has got a credit while trading the short put ladder. This may happen rarely, but mostly you will have to pay a debit to trade this. If you get a credit this is a slightly better trade as if all the options expire worthless, you can keep the cash you got while putting this trade. But we don’t trade this to get a credit – we trade this because our view is bearish. However for bearish views there are better trades which I will discuss later. In the example below you will see that I had to pay money to trade this.

As usual let me get real prices from the trading floor.

Date: 30th of December 2014
Spot Nifty: 8248 (Will treat 8200 as ATM)
India VIX: 14.86 (Average)
All options expiring on 29-Jan-2015 (30 days from today) and rounded off.

1. Sell 1 In The Money (ITM) Option: 8300 PE available at 119.00
2. Buy 1 At The Money (ATM) Option: 8200 PE available at 85.00
3. Buy 1 Out of The Money (OTM) Option: 8100 PE available at 60.00

Assuming 100 shares (4 lots of Nifty) were traded in each option.
Lets see whether the trader received a credit or had a debit on the trade:

8300 PE Sold: 119*100 = +11900
8200 PE Buy: 85*100 = -8500
8100 PE Buy: 60*100 = -6000

11900-8500-6000 = -2600

So the trader had to pay Rs. 2600 to trade this Short Put Ladder. Note that this is not his max loss, we will soon see what the max loss is.

Lets see what happens on the expiry day if:

Nifty at 8300:

All options expire worthless. The trader loses the initial investment of Rs. 2600. Note that above 8300 the results will be same.

Loss in percentage of investment: For this trade almost Rs. 60,000 will be blocked. (For real figures please check your broker’s platform). However it should be somewhere near 60,000.

(-2600/60000) * 100 = -4.3%

Nifty at 8200:

8300 PE at 100: Was sold for 119.00. 119-100 = 19*00 = +1900 (Profit)
8200 PE expires worthless: Was bought for 85. 85*100 = -8500 (Loss)
8100 PE expires worthless: Was bought for 60. 60*100 = -6000 (Loss)

Total Loss: 1900-8500-6000 = -12,600

Loss in percentage: (-12600/60000) * 100 = -21%.

This is the max loss in this trade. Are you comfortable with this kind of max loss? At least I am not. I would have taken a stop loss long back.

Very Important Note: Therefore any trades with such a huge max loss must be managed before things go out of hand. I have told this many times and will tell again that hoping something good will happen to your trades in future is NOT the right way to trade. It has more to do with your ego or fear than the stock markets. You must take your stop loss when you are not comfortable owning a trade.

Nifty at 8100:

8300 PE at 200: Was sold for 119.00. 119-200 = -81*100 = -8100 (Loss)
8200 PE at 100: Was bought for 85. 100-85 = 15*100 = +1500 (Profit)
8100 PE expires worthless: Was bought for 60. 60*100 = -6000 (Loss)

Total Loss: -8100+1500-6000 = -12,600

Loss in percentage: (-12600/60000) * 100 = -21%.

Nifty at 8000:

8300 PE at 300: Was sold for 119.00. 119-300 = -181*100 = -18100 (Loss)
8200 PE at 200: Was bought for 85. 200-85 = 115*100 = +11500 (Profit)
8100 PE at 100: Was bought for 60. 100-60 = 40*100 = +4000 (Profit)

Total Loss: -18100+11500+4000 = -2,600

Loss in percentage: (-2600/60000) * 100 = -4.3%

Now we will see some profits.

Nifty at 7900:

8300 PE at 400: Was sold for 119.00. 119-400 = -281*100 = -28100 (Loss)
8200 PE at 300: Was bought for 85. 300-85 = 215*100 = +21500 (Profit)
8100 PE at 200: Was bought for 60. 200-60 = 140*100 = +14000 (Profit)

Total Profit: -28100+21500+14000 = 7,400

Profit in percentage: (7400/60000) * 100 = 12.33%

Nifty at 7800:

8300 PE at 500: Was sold for 119.00. 119-500 = -381*100 = -38100 (Loss)
8200 PE at 400: Was bought for 85. 400-85 = 315*100 = +31500 (Profit)
8100 PE at 300: Was bought for 60. 300-60 = 240*100 = +24000 (Profit)

Total Profit: -38100+31500+24000 = 17,400

Profit in percentage: (17400/60000) * 100 = 29%

For every 100 points drop the trader makes a profit of +10,000.

But look again the trade results – Nifty has to fall from 8248 to 7900 to make some money for the trader. This is fall of 4.2%. How can we predict such a fall? If we can, we can simply buy ATM puts and make great money. 🙂

Real trading is quite different. Look at the graph above. See that the stock has to travel from the negative zone to positive zone to make some profits. In real world your patience will run out and you will take a stop loss much earlier.

Unfortunately what happens after that is of no use to you, as you will have already taken a stop loss when the stock was in the negative region. It of course cannot fly from 8248 to 7900, to just make a profit for you. Theretofore in my view this is not a good trade and should be avoided.

If you have a strong feeling of a market fall you can always buy an ATM put and sell an OTM put (put debit spread) or sell a ATM call and buy OTM call for protection (credit spread).

Fact is most of us cannot predict market direction therefore its very important that you learn conservative trades and be happy with the small returns it provides every month.

The worst part in this trade is that you cannot manage your losses. The only way to do is to take a stop loss. Therefore these kinds of trades must be avoided.

Conclusion:

If you love trading Ladders then you should learn how to trade a Short Call Ladder Strategy (or Short Put Ladder that I will discuss in my next post). The reason is that they have limited risk, unlimited profits potential (only on paper) – in reality Short Call Ladder is not a good strategy. We will shortly know why.

On paper they are better than Long Ladders because of the limited risk and unlimited profits – but unfortunately though limited, the risk is just too much on the Short Call Ladder and getting unlimited profits is difficult. Therefore you should know this strategy to actually avoid trading this. Still I highly recommend you read this article to enhance your knowledge.

I don’t have a problem with too much limited risk if the risk can be managed. However, with Short Call Ladder the only option is to take a stop loss if the risk increases beyond comfort level. Interestingly even that cannot be done as the stock has to travel from the worst zone to the best zone.

If you don’t know whether the stock will be in the best zone a few days from now or on expiry day – how can you even take a stop loss when the stock is in the worst zone? If you did not understand what I just said, it’s fine, I will discuss this later as well.

How to Trade a Short Call Ladder?

The view: If you think Nifty/Stock will move up during the next few days and volatility too will increase, Short Call Ladder is one of the (worst) strategies to play.

Note: There are many better strategies to play if your view is bullish. The risk-reward is good in this strategy, but only on paper. You will shortly know why this strategy is not a good bullish play.

The Short Call Ladder Trade:

Sell 1 Lot In The Money (ITM) Call Option
Buy 1 Lot At The Money (ATM) Call Option
Buy 1 Lot Out of The Money (OTM) Call Option

Risk: Limited
Reward: Unlimited

First have a look at the graph below and then read to understand the trade:

Please Note: In the above graph the trader has received a credit trading the Short Call Ladder. However when I looked for real prices that were given to me as a retail trader, I had to give a credit. In rare occasions you may also get a credit. If you get a credit this trade may be tried, because if the stock falls you will end up keeping the credit. If the stock rises too much, you end up making money. Still this is not a good trade as the credit you may receive will be small and not justify the risk you take.

I will now trade a real (paper) trade as an example to help you understand why this trade is not as good as it sounds. I highly recommend looking for some other trade like a debit spread trade if your view is bullish. You can even try long call ladder. Though in the long call ladder the risk is unlimited its a better trade in my view because the stock has to travel from a profitable zone to a loss making zone. You can always stop out your profits before the stock moves into the negative zone. 🙂

Lets do the trade:

Date: 22-December-2014
Time: 1.35 pm (Markets are Open)
Nifty Spot: 8247
India VIX (Volatility): 14.61

Note: Volatility may drop or rise, we don’t know. But still lets trade this as the results will be shown for the expiry day, so for this paper trade volatility does not matter.

(For people who don’t know, on the expiry day there is zero volatility and time value in an option. What is left is the intrinsic value. Therefore we are right now not much bothered about the Volatility.) However increase in Volatility will help as the trader here has double the number of buy options than sell options. Volatility helps the option buyer. (Increase in Volatility means option values will also increase.)

Lets get the Jan 2015 option prices online. Dec 2014 options will expire 3 days from today so I have taken January values:

Sell 1 Lot In The Money (ITM) Call: 29-Jan-15 8,200 CE: 209.75
Buy 1 Lot At The Money (ATM) Call: 29-Jan-15 8,300 CE: 148.00
Buy 1 Lot Out of The Money (OTM) Call: 29-Jan-15 8,400 CE: 98.90

Note: Since Nifty is at 8247 we could have traded this with 8100, 8200, & 8300 – with 8200 treated as ATM. In our current trade we are treating 8300 as ATM.

Had I done the trade with 8100-8300 my risk would have increased as I will buy the 8200 and 8300 option – though I will receive more from selling the 8100 option – my total outgoing will be bigger than the current trade.

I am not comfortable with putting too much money on risk, but your view may differ. Depending on your comfort level you can always treat slightly In The Money options (ITM) as At The Money (ATM).

You can say in that case I should have gone further up to save money. Well you have a valid question, but there is a problem. My risk will increase if I go up. Why will the risk increase? Because Nifty will have to move up significantly to generate profits. Later we will see why a significant move is required. A small movement will still be a loss for a short call ladder done on strikes deep out of the money.

The decision to trade which strike price is a VERY important decision for an option trader, especially if the trade involves trading At The Money (ATM) options and when the stock or Index is NOT exactly At The Money (ATM).

Some may say, I could have chosen the 8250, 8350 and 8450 options – but people who have taken my course know that I hate trading these options as they are not highly liquid. (Once I was not even able to take a stop loss in the 50s option because no one was trading. Result? By the time it was liquid I lost close to 17,000 🙁 . Lesson learned – stop trading options that are not liquid.)

Liquid options also helps to get a better fill, and make more money in the same effort because the ask and bid are very close. Moreover the results will be almost same. So why take the extra risk?

Now lets do the Short Call Ladder Trade. (To keep calculations simple I always do paper trading in 100 shares. Risk reward remains same for 1 lot or 4 lots on margin blocked):

Sell 8,200 CE: 209.75 * 100 = +20975
Buy 8,300 CE: 148.00 * 100 = -14800
Buy 8,400 CE: 98.90 * 100 = -9890

Total Debit: 20975-14800-9890 = 20975-14800-9890 = -3715

This is not our max risk. We will see soon max risk is too much in this trade.

Lets see the results on the expiry day:

Nifty at 8,200 on 29-Jan-15:

All options expire worthless. The trader loses Rs. 3715.00. Nifty expiring anywhere below 8200 the results will be same.

Nifty at 8,300 on 29-Jan-15:

Sell 8,200 CE will be 100: 20975 – (100 * 100) = +10975
Buy 8,300 CE will expire worthless: -14800
Buy 8,400 CE will expire worthless: -9890

Total Loss: 10975-14800-9890 = -13,715.00

This is our max risk. For selling 100 shares of Nifty almost 55,000 will be blocked. Since buying is for protection, most brokers will not block capital required for 8300, but for 8400 buy almost 10,000 will be blocked. Total margin required: 55000 + 10000 = 65,000.

Lets calculate the % max risk: (-13715/65000)*100 = -21.10%

Is this really limited risk? Are you comfortable losing 21% of your capital if wrong in just one trade? At least I am not. I don’t care what profits a trade can make – but if the risk is hard to manage and 21% of my money is at risk – I will not trade such a trade. Period.

Nifty at 8,400 on 29-Jan-15:

Sell 8,200 CE will be 200: 20975 – (200 * 100) = +975
Buy 8,300 CE will be 100: -14800 + (100 * 100) = -4800
Buy 8,400 CE will expire worthless: -9890

Total Loss: 975-4800-9890 = -13,715.00

Nifty at 8,500 on 29-Jan-15:

Sell 8,200 CE will be 300: 20975 – (300 * 100) = -9025
Buy 8,300 CE will be 200: -14800 + (200 * 100) = 5200
Buy 8,400 CE will be 100: -9890+ (100 * 100) = 110

Total Loss: -9025+5200+110 = -3715.00

Note: On expiry if Nifty is anywhere below 8500, the trader still loses. Remember that this trade was initiated when Nifty was at 8247. Even after traveling more than 3% if a bullish trade loses money then it cannot be called a good strategy. Had you done a debit spread you would have made great money by now.

Nifty at 8,600 on 29-Jan-15:

Sell 8,200 CE will be 400: 20975 – (400 * 100) = -19025
Buy 8,300 CE will be 300: -14800 + (300 * 100) = 15200
Buy 8,400 CE will be 200: -9890+ (200 * 100) = 10110

Total Profit: -19025+15200+10110 = 6285.00

Nifty at 8,700 on 29-Jan-15:

Sell 8,200 CE will be 500: 20975 – (500 * 100) = -29025
Buy 8,300 CE will be 400: -14800 + (400 * 100) = 25200
Buy 8,400 CE will be 300: -9890+ (300 * 100) = 20110

Total Profit: -29025+25200+20110 = 16285.00

With every 100 points up-move the profits will increase by Rs. 10,000.00.

Now let me tell you why I told earlier that “if you don’t know whether the stock will be in the best zone a few days from now or on expiry day – how can you even take a stop loss?”

The problem as you can now see from the above results is that to get into a profitable zone Nifty will have to travel through the worst zone that is from 8247 to 8500 and then some more to make a decent profit for the trader.

In real world the trader will become nervous even if Nifty is climbing up. Why? Because its a long journey for it to travel to hit the profitable zone. In desperation the trader will book a loss somewhere between 8300 and 8400 (the worst zone), never waiting for the real profits to come.

This is again a big reason as to why this trade should not be done on deep Out of The Money (OTM) options. Your total money on risk may reduce, but chances of losing money also increases. Here even after a 3% move, the trade is in loss. A deep out of the money trade may be a loser even after a 5% move.

Yes, if VIX increases substantially and expiry is a few days away, there is a chance that the trade will be in small profit even in the 8300-8500 zone. But what are the chances for that? Usually VIX decreases when Nifty is going up. This again is negative for this trade.

In view of the above, this trade is best avoidable. Look for other trades when bullish. But I hope you gained some knowledge out of this article. If yes my job is done. 🙂

Conclusion:

• In Short Call Ladder a trader sells one ITM call, and buys one ATM call and one more OTM call.
• The stock needs a significant move up to realize a profit.
• Risk-reward is good on paper, bad in real trade because the stock has to travel from a negative zone to a positive zone. The trader will almost always stop out in the negative zone.
• Avoid this trade, look for better trades when bullish.

Do share your experiences of trading a Short Call Ladder or any other ladder strategy.

The Long Put Ladder Strategy is a trade where you have a mildly bearish view on a stock. Read to know how to trade it well.

Recently I wrote an article on Long Call Ladder, today I will discuss the Long Put Ladder.

The Long Put Ladder is exactly opposite of the Long Call Ladder. Therefore the view of the trader should also be opposite.

In the Long Call Ladder the trader was a bit bullish, in the Long Put Ladder the trader is a bit bearish. In both trades the trades has a bearish view on volatility.

Both strategies are limited reward but unlimited loss strategies.

Why is the trader also bearish on volatility? We will know shortly.

How to Trade the Long Put Ladder Strategy?

If you are bearish on a stock or Nifty you can:

1. Buy 1 ITM (In The Money) Put Option
2. Sell 1 ATM (At The Money) Put Option
3. Sell 1 OTM (Out of The Money) Put Option

Risk is Unlimited & Reward is Limited.

Lets take real prices and discuss one trade.

Date: 11-December-2014
Nifty closing spot price: 8293.00. Option prices are also closing prices.
India VIX: 12.77

Lets trade 100 shares (4 lots) each to keep math’s simple:

1. Buy 24-Dec-14 PE 8,400.00: 98.60
2. Sell 24-Dec-14 PE 8,300.00: 52.30
3. Sell 24-Dec-14 PE 8,200.00: 24.70

Debit: 98.60 * 100 = -9860
Credit: (52.3*100) + (24.70*100) = +7700

So the trader pays money to trade this: 7700-9860 = -2160.

Note: Ideally the ladder trades are played in a situation when the trader gets a credit to trade this strategy. It is because, if his view is wrong and all the options expire worthless, he still gets to keep some money. Go back to the long ladder strategy and see that there the trader was paid a credit to trade the strategy. Though less it makes sense to trade this strategy only when you are getting a credit. However if your view is very strong, you can trade even with a debit.

If you look at the trade closely it is actually a put debit spread with one extra uncovered sold put option. This one extra uncovered put is sold to reduce the cost of buying the ITM put. Usually in the money options are very costly – so the traders look for ways to reduce the cost of buying an option. This is one of the ways.

One more point. It gives a sense of protection too. Because the trader is not selling an option totally unhedged. There are two sold options hedged by 1 bought in the money option. This in the money option will have delta more than any of the sold options. Unfortunately it is still not enough delta to save the trader if an unexpected fall comes through very fast.

If that looks complicated please do not worry. In simple language if Nifty falls the trader is protected to some extent till Nifty reaches 8200 – this is where his worries will begin. Any fall further will be damaging to the trader. Here is where he should take a stop loss. He will still suffer a loss if the expiry is not near, but the loss will be small. Fall after 8200 will escalate the losses fast because 8200 will become in the money.

Now after this discussion lets see his profit and loss on the expiry day.

Case 1) Expiry at the 8400:

All options expire worthless. The trader loses the initial investment of 2160. Anything above the result is same.

Case 2) Expiry at the 8300:

1. Buy 24-Dec-14 PE 8,400.00: (100*100) – 9860 = +140 (Value of 8400 will be 100)
2. Sell 24-Dec-14 PE 8,300.00: 52.30 – expires worthless = +5230
3. Sell 24-Dec-14 PE 8,200.00: 24.70 – expires worthless = +2470

Total profit: 140+5230+2470 = 7840

ROI: For selling 1 lot of 25 shares approx Rs. 13,000 is blocked.
200 shares were sold. 200/25 = 8 * 13000 = Rs. 104,000
For buying 8400 put slightly less money will be blocked as the trader has some sold options too. Assuming 6000 blocked.

104,000 + 6000 = 110,000 blocked for this trade.

(7840 / 110000) * 100 = 7.12% returns. Only 14 days are left for December expiry. So the trader makes a return of 7.12% in 14 days. This is an amazing return. Unfortunately the direction needs to be predicted. If we all could predict the direction we all can be millionaires in no time. 🙂

Case 3) Expiry at the 8200:

1. Buy 24-Dec-14 PE 8,400.00: (200*100) – 9860 = +10140 (Value of 8400 will be 200)
2. Sell 24-Dec-14 PE 8,300.00: 5230 – (100*100) = -4770 (Value of 8300 will be 100)
3. Sell 24-Dec-14 PE 8,200.00: 24.70 – expires worthless = +2470

Total profit: 10140-4770+2470 = 7840

As you can see the results are same as expiry at 8300. But drop from here onwards will be costly for the trader. Let’s see.

Case 4) Expiry at the 8100:

1. Buy 24-Dec-14 PE 8,400.00: (300*100) – 9860 = +20140 (Value of 8400 will be 300)
2. Sell 24-Dec-14 PE 8,300.00: 5230 – (200*100) = -14770 (Value of 8300 will be 200)
3. Sell 24-Dec-14 PE 8,200.00: 2470 – (100*100) = -7530 (Value of 8200 will be 100)

Total loss: 20140-14770-7530 = -2160 (Note that the loss is same as all options expiring worthless i.e. Nifty expiring at or above 8400)

Case 5) Expiry at the 8000:

1. Buy 24-Dec-14 PE 8,400.00: (400*100) – 9860 = +30140 (Value of 8400 will be 400)
2. Sell 24-Dec-14 PE 8,300.00: 5230 – (300*100) = -24770 (Value of 8300 will be 300)
3. Sell 24-Dec-14 PE 8,200.00: 2470 – (200*100) = -17530 (Value of 8200 will be 200)

Total loss: 30140-24770-17530 = -12160 (Note that the loss is Rs. 10,000 more than expiry at 8100. Similarly you can guess the loss if Nifty falls further).

Now an important note:

A good trader NEVER wait tills expiry especially in the trades where he can face unlimited losses. He will surly take a stop loss or do an adjustment to the trade. He knows that sitting on hope is not good way to trade. Therefore I had written that he expects the volatility to decrease.

He has sold 2 options and bought one. So if the volatility decreases, he will profit fast from the sold options to bring down the cash paid to buy the ITM option. This happens especially if Nifty moves up a little or consolidating and volatility drops. In that case he may exit the OTM sold option if he thinks there is nothing much left in that option.

He may choose to exit the ATM sold option too if there is a huge drop in volatility and he is making a good profit on that. If this happens the trader will reduce the cost of buying the ITM option drastically.

Essentially now he can wait for the unlimited profits that may come from a huge fall in Nifty because he has now no more short options left.

This is called smart trading that you must try to accomplish as a trader if the goal is to become a good trader.

Of course if there is a reasonable profit in the whole trade after sometime he will exit from all the three options.

But you should not trade this with the above in mind. Every trade may not result in the same way. It is experience and education that helps determine what needs to be done with the bought and the sold options. Sometimes even after taking the profits from the sold option a trader may have made more had he not bought them earlier in profits.

Some people may not agree to this as they may say its timing of the market. No its not. Once the volatility drops or Nifty inches higher which brings profits to the sold option – its all nothing but simple math’s. Now you just need to calculate the profits from the sold option to see what is the max loss on the trade. If you are comfortable with that max loss now left for the trade, you can take the profits out from the sold options. Since the loss now will be limited.

If Nifty falls, great you make profits from ALL options, else you may have to be satisfied with the loss that you were ready to take anyway. Note that this loss may be more than the initial credit made for the trade, but still much less than had you bought the ITM option unhedged.

Have you ever traded a ladder? If yes it will be great to hear from you. Please do drop a line or two in the comments section.

Thank You.

Directional Trading has lots of benefits as well as risks. You should have strong risk management in place when you take on directional trades.

I started giving 2 conservative directional trades in my course due to the simple reason that almost everyone who called me to inquire about the course said that they like to play directional trades. In fact none of them used to trade non-directional trades, but were interested in them, so asked about the course.

Old habits die hard. I know that even after taking my course some time later they may try a directional trade and end up losing whatever they made in months or even years through the non-directional trading in just one wrong directional play. Yes it can get that risky.

For example lets say in 3 months a trader made around 100 points and took a buy call in Future. Next day Nifty opens gap down 100 points – Bump – Gone! In panic he will cover the Future in a loss. Whatever made in the last 3 months gone in a day. Now start again, very low on motivation. Bad.

Have a look at an email I received recently. See how this trader lost in lakhs trading directional calls/puts.

Directional Strategy Trader Lost Lakhs – Click to Enlarge

This happens to a lot of traders. To overcome this my course now includes 2 conservative directional trades as well, to help traders not lose much money playing directional trades if they are wrong, and make more if right. In fact in the above situation they will make money.

Of course I cannot reveal what’s there in the course but what I can say is most traders playing directional trades are doing it the wrong way.

In this post I will help you know how to trade directional trades better. Please read in full to know.

There are few benefits of directional trades. Here are they:

1. Risk reward especially with options is extremely good. Risk is Limited, Reward Unlimited (on paper 🙂 ). You can actually double your money every month. (Though I guarantee there is no one on Earth who does that.) Some or the other option definitely doubles in 20 trading days. The problem is we just don’t know which one.

If you can know that option, put your money there. Unfortunately its almost impossible to time the markets. And I don’t think there is anyone in this world even with the best technical skills to predict with certainty where the markets are headed and in what time. Well some may be good at predicting whether Nifty will go up or down over the medium term, but no one can definitely predict in what time Nifty will be where.

Since timing of the movement is extremely difficult (well impossible) most option buyers lose money.

2. Risk reward is same in futures. Yes it is same but you can always bring options into the picture to make the risk-reward favorable to you. This is what my directional trades teach. So even if you are 50% right, you should make money.

3. Money comes pretty fast. The beauty of directional trades is that results are pretty fast. You will know in a few days (sometimes the same day), whether you have made a profit or a loss. Great for people who are into the markets for fun.

Yes you may not know, but there are lot of people who are into the options market for fun. One day a trader called me and asked for a strategy that makes money every other day. Tell me how can I help him? Only God can help him. How can there be any strategy that makes money every other day? If you want to make money every other day, you will lose money every other day. In fact you will lose a lot of money every other month. 🙂

Stock markets do not like people who are Greedy. They don’t know but stock markets are rich because of those greedy people. Believe me the only way to make money from the stock markets is to make money slowly overtime. Small profits accumulated overtime becomes huge money.

If you are in the markets to make a lot of money quickly – you may get some fun but no money. After sometime it may not be fun too! Is losing money fun really? 🙂

Please do not live on hope – doubling money every year from the stock markets or making a lakh from a lakh in your account is simply not possible. If you are one of those traders who think that day will definitely come – then let me give some bad news to you – that day will NEVER come.

You will keep on living on hope and losing money doing all the trials and errors in the world. Please do not waste your hard earned money. Be conservative.

So what are the risks in the directional trades? Well a lot.

1. If you make money fast, you lose money fast too. If your risk-reward is not good you will end up losing more than you make.

2. Most traders do not have a proper risk management in place. So what happens is this – when profits come you will take them away in a swift, but when losses comes you will keep waiting for a market reversal. You will keep praying to Gods for help. Was not taking a stop-loss at the appropriate time Gods mistake? Why should Gods help you?

Markets will do what they want to do. They won’t reverse because a trader is losing money. Ultimately when markets do not reverse you will see that you ended up losing 5 times of what you made in your last profitable trade. Losses multiplies by 5 to profits. Frankly this is what I hear from most traders. This will not happen if you have a good risk management in place.

3. Directional trades makes you greedy. Mostly you win the first time. This is called “Beginners Luck“. Once you win you start thinking you have a “God Gift” of predicting markets. Your job is useless. You deserve a better life. You then take a lot of money out from all sources (sometimes even a loan) and gamble in the stock markets taking directional calls. You lose all of it and curse yourself for being greedy. But what has happened has happened. You will not get your money back. Period. Here is one trader who lost more than 40 lakhs because he just couldn’t control greed.

In my course the directional trades are perfectly hedged. So what happens is on Rs.10 invested, you make Rs.7 or you lose Rs.3. When you win you make more, when you lose you lose less. But I have told them to book profits/loss on 100 points at least. The reason is you give room for Nifty to move. And since the losses are less, you can take that chance.

Here is another example of greed. After taking my course one trader mailed me this:

In your directional trade strategy, if I am looking for 25 points as profit and 25 points as stop loss, how to execute this trade?

Which means he essentially wanted to turn it into an Intraday trading and know at the end of the day whether he made a profit or loss. Dude you can find better ways to pass time – markets are not the place to have fun.

When its clearly written you got to wait for a 100 point movement then you got to wait. That is what the strategy was made for in the first place. You just cannot tweak it for fun. People who do not have patience should not trade options in the first place.

This is what I replied:

The problem with small Stop Loss and Profit is that either can be hit very fast – it gets mostly Intraday. Your trade is correct but I do not like trades with no room to move. For example will Nifty go to 8600 or 8400 is an easy guess than Nifty moving from 8525 to 8550.

Another simple example is when you buy a stock, do you buy it to sell it the next day? Ok sometimes it does appreciates in value in 1 day and you can sell to make a quick buck or two. But mostly we buy stocks to keep them for a long period to make money right? When we can show patience there why can’t we show the same patience when we trade with options?

Here are a few tips on How To Do Directional Trading:

1. Strict risk management should be in place: Do not trade on hope. Have proper risk management. Always think of the worst case scenario. Do not place all your money in a single trade. If that goes bust, all your trading money is gone. You will be left with nothing to trade. You should never be in such a situation. So please trade in small size.

One good risk management is keep your profits double the size of your loss. So if you want to target 50 points as profits, your stop loss should be 25 or max 30 points. Which means if you hit target two times, it will take four failures to undo that. Though.

2. Write your target profit or loss in your trade plan. When that is hit just exit the trade. There is nothing called hope in the stock markets. If target profit is hit, be ready to take those profits. If a loss is hit, just take the loss. No egos on either profits or losses. You made money or lost it. It was nothing else.

3. Reduce your cost of trade: When you buy a call, sell a call. And when you sell a call you should buy a call for protection.

For example if you think Nifty may go up then you may:

Buy 24-Dec-14 CE 8,500.00 151.00
Sell 24-Dec-14 CE 8,600.00 87.25

(Taken from 04-Dec-2014 closing price.)

Had you bought 8500 calls without hedge, the risk on 2 lots is: 151 * 50 = Rs.7,550.00
Whereas because you sold 2 lots of 8600 CE your risk reduces by: 87.25 * 50 = Rs.4362.50

Total money at risk: 7550 – 4362.5 = Rs.3187.50 only.

Can you see the beauty of hedging? Now you can easily wait until Nifty hits either 8600 or 8400. 8600 is where you can take your profits out, and 8400 means you got to take the loss. Yes your profits will reduce too, but the losses will also reduce significantly.

Here is another article I wrote on how to reduce the cost of buying an option.

Imagine the same trade with a 25 points leeway. The trader will hit stop loss most of the times. Where is the money?

You can do the same if you think Nifty will go down, that is buy a put and sell OTM put.

4. If you are trading futures protect yourself from unlimited losses. You can do it by buying some protection using options. This is described in details in my course to do it in the best possible way.

5. Relax: If you are doing it conservatively you can relax and trade freely. If you are taking unlimited risk you can never relax and a non-relaxed trader loses money.

I know most of you take directional trades. Do you do anything to reduce risk?

The Long Call Ladder Strategy is often suggested by experts in the moneycontrol website. I do not know for what reason, but I have read this many times there.

What is the Long Call Ladder Strategy?

This strategy is established when a trader has a slightly bullish view but thinks that the stock will not keep rising up and expire at a certain level not far from the current price. He can then trade this strategy.

The strategy:

1. Buy 1 ITM Call Option
2. Sell 1 ATM Call Option
3. Sell 1 OTM Call Option

Reward: Limited
Risk: Unlimited on the upside till expiry

Have a look at the graph:

Unlimited risk is only when the stock keeps rising beyond the last OTM call sold. On the downside profit and loss depends on whether the trader took a credit or paid money to initiate the trade. Expiry in between the strike prices of call bought and sold results in profits. Max profit is if the stock expires between the call options sold.

Now go back and look at the three steps required to create the long call ladder. If you take out step 3 – all that is left is a debit call spread. In simple language if the stock moves up the call debit spread should make money. However debit spreads are costly. If you buy 1 in the money call option and sell one at the money call option in Nifty and if they are 100 points apart – the minimum difference of points will be 50. Which means you have to pay for 50 points at least to establish step 1 and step 2.

Some people are not comfortable with this, as paying for 50 points is costly. If Nifty does not move up, or goes below and expires below the strike price of the option bought – the trader will lose all 50 points.

To reduce the risk the trader sells another call option further out of the money. This makes sure his losses gets reduced by a huge margin.

A lot of Indian retail traders trade this strategy but do not know that they are trading long call ladder. They feel happy for the fact that they were able to reduce the risk by paying less or getting a credit. On top of that if Nifty actually does not travel beyond the far OTM call option – which seems unlikely when the trade was initiated – then the trader makes more profit.

Little does he realize that he is actually taking a unlimited risk because of one extra sold option. What seems unlikely today my become a reality tomorrow. 🙂

Let me take real example from Nifty.

Trade date: November 25, 2014
Spot Nifty: 8480
India VIX: 13.29

We will trade December 2014 options because time to expiry for the November options is just a few days away that will be risky. We will do it in 100 shares to keep the math simple.

Buy 1 ITM Call Option: 24-Dec-14 CE 8,400.00 @ 187.00
Sell 1 ATM Call Option: 24-Dec-14 CE 8,500.00 @ 123.00
Sell 1 OTM Call Option: 24-Dec-14 CE 8,600.00 @ 73.00

Total credit: (-18700+12300+7300) = 900.

Please note that sometimes a debit may also occur depending on which options were sold. For example the trader can also sell the 8600 CE, and 8700 CE call option trading at 73 and 40 respectively.

In that case the trader will have to pay a debit (-18700+7300+4000 = -7400). As you can see just by shifting 100 points up, the trader have to pay a large debit. On the other hand his chances of profits increases. Now he need not bother up to 8700, but in the earlier trade his stress starts when Nifty reaches 8600.

If you trade the above you will receive Rs. 900 the next day in your trading account. This is not your max profit. Lets discuss the profit or loss on the expiry day.

Nifty at 8400:

All the options expire worthless. You can keep Rs. 900/- you got when you put on this trade.

ROI: (900/120000)*100 = 0.75% (Assuming Rs. 100,000 was blocked as margin for selling 200 shares – 8 lots of 25 shares each – and some 20,000 blocked for buying the ITM option)

Anything below the result will be same.

Nifty at 8500:

8400 CE: will be 100. (-18700+10000) = -8700
8500 CE and 8600 CE expire worthless = 12300+7300 = 19600

Result: 19600-8700 = 10900 (This is your max profit)

ROI: (10900/120000)*100 = 9.08%. Amazing profit in almost 30 days. But please understand that this was possible because Nifty expired at the sweet spot. The sweet spot is between 8500 and 8600 – beyond this the profits will start to decrease and losses will start. Lets see how.

Nifty at 8600:

8400 CE: will be 200. (-18700+20000) = 1300
8500 CE: will be 100. (12300 – 10000) = 2300
8600 CE: will expire worthless. 7300

Result: 1300+2300+7300 = 10900 (This is max profit – if Nifty keeps traveling further profits starts to decrease.)

Nifty at 8700:

8400 CE: will be 300. (-18700+30000) = 11300
8500 CE: will be 200. (12300 – 20000) = -7700
8600 CE: will be 100. (7300 – 10000) = -2700

Result: 11300 – 7700 – 2700 = 900 (Profits reduced by 91.75%)

Nifty at 8800:

8400 CE: will be 400. (-18700+40000) = 21300
8500 CE: will be 300. (12300 – 30000) = -17700
8600 CE: will be 200. (7300 – 20000) = -12700

Result: 21300-17700-12700 = -9100

See how fast the losses are accumulating.

Losses will keep increasing as Nifty keeps rising.

Long Call Ladder Strategy works best if the stock or the index is between the sold options on expiry day. Else the profits may vary depending on the position. Losses starts to accumulate if the stock is above the 2nd call option sold.

Note that some traders sell 2 ATM options instead of selling one ATM and one OTM option to get extra credit. This is not a good trade as the losses starts to accumulate very fast once Nifty crosses the sold option strike.

Strategies are recommended for a reason and if you do not have a very solid reason to change a strategy you should not try it. In most cases you will lose money.

Adjustments to the Long Call Ladder Strategy

1. If Nifty is falling – no adjustments required. Be happy with the 0.75% return that month. Do not bring down the ladder – if Nifty again starts moving up, you may lose money.

2. Rollover to the next option prices 100 points away as soon as Nifty crosses the first option sold strike. In most cases the trade here will be in profit. In that case there is no need to rollover. To get that 9.08% you may rollover and may end up losing money. So be happy with whatever you got. Hard to tell the profits you will receive here as it depends a lot on the option price prevailing at that time.

3. In any case DO NOT let Nifty cross the second call option sold. If it has reached there – it is almost certain that you are in good profit. Theta may have done damage to the sold options by now and the bought ITM option will be in good profit – so the whole trade will be in profit. BUT you will still not receive the stellar 9.08% return if expiry is far away.

Do not be greedy. Nifty may again fall or keep traveling up and a profitable trade today will be in loss on the expiry day. So just take your profits and close the trade. You will get another opportunity to trade. Free your cash for that.

This trade looks easy, but mind it, its not. Why? Lets discuss the reasons.

1. If Nifty keeps falling – your profits are just 0.75%. This is less than what a short-term debt fund returns in a month with zero work or stress. This is not a satisfying return trading options. Sometimes the returns may be lesser or you may have to pay cash to trade ladder. In those cases you may lose money.

2. If Nifty is range bound – you will be eager to take profits because of the fear that Nifty may fall and you may lose whatever money you made till now. You will make a profit but the returns will not be great. This is most likely to happen to any trader.

3. If Nifty keeps rising – greed will come in and you will feel like waiting till expiry to take that 9.08% return only to find on expiry day that Nifty has crossed the second option sold and you may have a loss or small profit.

Therefore it is important in any trade to know well in advance where you shall book your profits or take a loss. Maximum profit and maximum loss in any trade should be known to you – but they should not be the only criteria to take a profit or loss. Your profit or loss should be decided by you as a trader – not what the math are showing.

If you have traded the Long Call Ladder Strategy let us know your trade in the comments section. We can discuss the results. This will also help other traders.