Selling deep out of money PUT options

F&O
1

hi,

I am just starting off and trying to get some knowledge on option selling and verify, if my understanding is correct. I am going to keep the example with round figures so that calculations are simpler to explain.

Lets say Bank Nifty is currently at 36000 on Monday and I am talking about weekly expiry. I go and sell a deep out of money PUT option with 34200 strike price at premium of Rs 201. Lets say, I sell 4 lots of 25 and I paid brokerage, STT etc of Rs 100. So I get net 20K as premium. Now is it safe that say that until Bank Nifty closes above 34001, I am not losing money?

Above 34200, i get all premium and between 34001 and 34200, I am getting the difference in premium minus difference in strike price and spot price. So if Bank Nifty closes at 34100 on expiry, I still make a net profit of 10K ?

Now lets say, Bank Nifty closes at 33700 on expiry and I have NOT squared off my position. So now my overall loss is premium received (200) - difference in strike price and spot price (34200-33700 i.e 500). So net loss of 300. Since I have 4 lots, I will have net loss of 30K. Is this calculation correct? Now on the buy side, is the STT applied on the spot price or on difference? I am not clear on this front.

In second scenario, lets say Bank Nifty does not move much and closes around 35900 or 36100 on expiry and I have NOT squared off my position. So my PUT options will expiry worthless. Is there any brokerage, STT or any other charges to be paid in this scenario, if I take no action?

Last question is, since I sold the PUT option on Monday, by Wednesday lets say, Bank Nifty is already down to 34800. So the probability of Bank Nifty ending below 34200 has drastically increased. So in such a case, in order to somewhat offset the expected losses, is it better to sell one more out of the money at different strike price (say 34000 or 33800) or is it better sell additional lot at same strike price of 34200, but now at a much higher premium?

I understand that in times like now, when volatility is very high and driven by many external factors, any deep out of money PUT can become in the money in a single day. So loss can increase multifold in a very short time. But during normal times in a sideways market or slightly bullish market, is using this naked deep out of the money short strategy relatively safe with a limited upside potential?

Thanks!

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One black swan event away from getting rekt.

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Most of the times this strategy would make money. Except that ONE time when shit hits the fan. Have a look at the Russian markets, for example.

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Or have a look at Crude Oil.

In my opinion, any sort of speculative unhedged position is risky. If you want to be secure, either hedge it so that your losses are capped or have cash ready so that you are actually able to buy the underlying should your options come in the money.

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A naked sell strategy has unlimited risk for miniscule profit per trade. High accuracy yes but accuracy in trading is overrated which one will find out on a blackswan day. Even with hedged far OTM sell strategies one stands to loose all or most of what was made till and on a black swan day.

Discretionary fire fighting strategies could be used but then it cannot be demonstrated as a process. Its mostly instincts and gut feels and no guarantee that it will work.

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100%

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Got it. So when you say, have the money to buy the underlying, how does the calculation work with Index options where PUT was sold, which ends up in the money? In the example that I had shared before (PUT with strike price 34500 sold and on expiry, Bank Nifty closes at 34200) , considering 4 lots, am I expected to have 34200x25x4 i.e 34.2 Lakh OR am I expected to have the margin amount (which was already blocked, when I sold the PUT option …roughly may be 1 to 1.25L. So for 4 lots 4-5L) ?

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Agree. Black Swan days can wipeout almost anything. Also risk to reward ratio is not at all great with naked sell option. But like I mentioned in my original post, this question was about using this strategy during a period, when market is relatively stable… i.e. either sideways or slightly to very bullish, with the assumption that we dont trade in large quantities…may be 1 to 5 lots max.

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The problem with this strategy is limited earning potential with the potential to lose big when things go wrong. Naked trades are always risky, so do keep your positions covered at all times.

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What I was describing is a cash secured put. You sell the put with the intention of buying the underlying at a certain price, in your case it is 34200. If the underlying comes to 34200, then you invest the cash which you had set aside. If the underlying does not come to 34200, you get to keep the premium.

If you are selling 25 x 4 = 100 qty at 34200, then ideally you should have 34.2 lacs of free cash kept aside for this purpose. This keeps your risk in check because otherwise you can sell any number of puts on margin hoping to keep the premium and in most cases, you might actually be successful. But, this strategy will help you survive on that ONE time when everything goes haywire.

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Got it. So apart from risk management perspective, this kind of large amount requirement will also help to keep any unwanted greed in check as well.

Also, from broker perspective, since they allow to trade based on span + exposure, do they increase blocked margin requirement for the already sold lots as the date nears expiry or if the spot price nears the strike price of the held price? Will there be case where they automatically square off the existing position before expiry ?

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Well market may be stable today but no guarantee that it will be the same next day. Anything can happen any day and it cannot be predicted by us mortals with a fair probability. This means a strategy when made should account for the worst case outcome.

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Agreed with all the points highlighted by @t7support …

Seems like you are a starter in option selling world. If yes, i would suggest you the following points, which will generate you consistent returns and even during a black swan event, it won’t wipe out your capital completely and even that can be avoided with some fire fighting skills.

I would suggest you to stay away from Banknifty. Its a wild animal that moves 1200-1500 plus/minus in one day also during such volatile times. Its very difficult for a beginner to manage such trades. M2M losses will wreck your psychology and give you heart attacks.

Never ever sell naked puts, never. Instead you can do an iron condor which is selling OTM puts & calls and hedging it with even far OTM calls & puts. You can do it on Nifty weekly expiries, which is easier to manage compared to BN.

Say nifty is trading at 17000. You can sell 16500PE and 17500CE. Hedge both with 200 points away calls & puts which will also give you margin benefits and to some extent protect you from black swans even if you don’t square off.

As and when market continues to move in one direction, say towards to put position of 16500, you can book profit with call position and bring the call side down, say towards 17000CE.

Keep practicing one lot of nifty until you get hold of the swings and you can make your own rules based on it (when to adjust positions, when to book losses, etc.)

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14

Also, something to ponder upon, you have thought about selling PUTS. Why not think about selling CALLS?

Have you seen any overnight black swan event that may have caused markets to go up by let’s say 6-10%?

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To add to this, recently last month the market crashed 800 points in a single day and on the next day rallied 500+ points (probably due to profit booking for short positions, and new people buying the dips :stuck_out_tongue: )

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With an Iron condor your worst case lose is around 20% of capital if you hedge with strikes 200 points away. The profit I assume is around 1% per week. If this be the case then you can work out the accuracy needed is around 95% just to break even accounting for a black swan day.

Am not even touching on the discretionary angle needed for this strategy - the effort, time for adjustments and formulating dynamically changing market views.

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That definitely I am :slight_smile: hence all these questions. Again, I am not planning to apply these strategies immediately in current volatile market. Just preparing for some near future. For the time being, I am only planning to do virtual trading to get a hang of it. Thanks for the guidance and example.

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This is easier said than done. It takes a lot of experience and time in the markets to be able to adjust and absorb the notional MTM loss that can crop up to hold onto your position until expiry. Over a period of time you will get battle hardened and focused on what to be able to do in a 800+ gap down or 500+ gap up.

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Yes. I have considered that (selling calls). Black swan events may look to be happening more frequently in current volatile markets. So what everyone is suggesting definitely makes perfect sense in current volatile conditions. But I am looking to prepare for strategy to use during a more normal market.

My initial take (which may be incorrect due to lack of experience) is that as a beginner, I may no be able to consistently predict daily market up move which will be a more frequent event in normal market conditions. So market doesn’t have to go up by 6% in one day. But if I am looking to leverage expiry, then a 2-3 day upmove can easily meet the 6% condition. Where as with Black swan events, I can at least take some educated guess and try to stay out of market during those volatile times. So as a beginner in normal market, I think that selling puts are less risker compared to selling calls as market upmove will be a more frequent event. So until I gain some experience, understand the market, be able to read charts and gain some confidence to somewhat predict the moves using different patterns, essentially have a proper system in place to trade, I think that I will be more comfortable with selling puts.

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I’m biased toward option buying, so can’t argue here

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