How To Earn Safe Money From Options
Options are powerful financial products which can give you significant returns on your money. Trading in options is highly exciting and many are happily doing it every day for a long time. However, any others find it very difficult to understand options properly and they end up making unnecessary losses by trading in options without understanding the proper risks.
However, trading in options can help you to make safe money if you learn certain strategies which do not involve taking too much of risks. We will be talking about one such strategy here.
In this article, we are presuming that you already know what options are. If you don’t, then feel free to browse the other resources on this website or get in touch with us to join an options trading course that we offer.
Call and Puts
Calls and puts are the two basic types of options which you can use to trade in the markets. There are four basic options strategies which you can start your trading with. The following are the views and puts associated with each of these strategies:
| Strategy | View | Return | Risk |
|---|---|---|---|
| Buy Call | Bullish | Unlimited | Limited to the premium paid |
| Sell Call | Bearish | Limited | Limited to the premium received |
| Buy put | Bearish | Unlimited | Limited to the premium paid |
| Sell put | Bullish | Limited | Limited to the premium received |
What is safe money?
We all know that to earn higher returns you will have to take higher risks. However, there are ways in which you can on decent returns while minimizing your risks. This is done by hedging your trading positions.
Options were originally created as a tool for hedging other trading positions in stocks futures and options. However, the usage of the product got modified heavily and soon people started using options as trading tools.
To make safe money you will have to go back to the basics, i.e. use options as a heading tool. By safe money, we mean returns which you earn consistently while taking a low or zero risks.
Let us now understand the option strategy which will enable you to earn safe money.
The strategy:
The hedging strategy which will allow was to make safe money is very simple to understand. The biggest advantage of this strategy is that it is very easy to execute it too.
Unlike the basic option strategies that we have discussed earlier, this strategy is a two-legged on that is created by going:
- Long on stock
- Long on put
How many puts should you buy?
This is a very important decision which is going to determine how well you have hedged your position. How many puts you need to buy will depend on the delta of the put.
There can be three scenarios:
- If you want zero loss, you will have to completely neutralize the delta. From my experience, I have seen that you will need to buy 2 ATM puts in order to perfectly hedge your futures position. The positive point about this strategy is that you will not enter any losses when the markets go down. However, the problem with this strategy is that you will not make any profits when the markets go up either. You will only make money when the markets move sideways heavily.
- If you want to avoid unlimited loss
The strike price that you need to select will depend on your view about the future movement of the market.
Which share do you buy?
There is a listed Exchange Traded Fund in the markets which is known as Nifty BeES. The portfolio of Nifty BeES is identical to that of Nifty. It behaves in the same way as Nifty and any movement in Nifty causes the price of Nifty BeES to go up and down. It also has most of the characteristics of a listed share.
The price of 1 Nifty BeES is equal to 1/10 price of the Nifty index.
Advantages and disadvantages of NiftyBeES
Buying Nifty BeES has the following advantages over buying Nifty futures:
- You do not have to pay mark-to-market margins
- There is no need to carry forward the positions at the end of the month. Therefore you save on brokerage costs and carry forward charges.
The problem with Nifty BeES is that you will have to take delivery of the shares by paying the full amount as well as delivery brokerage. Hence a larger part of your capital gets blocked in this strategy.
Executing the strategy:
I strongly suggest that you execute this strategy in the following way:
- Buy Nifty BeES
- Buy Nifty puts to hedge Nifty BeES
The current value of Nifty is 7601 and Nifty BeES is 771. Since I already mentioned that 1 Nifty BeES =1/10 of Nifty, we can see that there is a difference of Rs. 11 in the value (Rs 771 – Rs. 760).
This difference is due to the dividend that Nifty is carrying at present. You need not worry about paying this extra amount while buying Nifty BeES because when the dividend is declared you are going to receive it as a payout anyway.
Here is how you will execute the strategy:
| Buy | Quantity | Price | Amount spent (Rs) |
|---|---|---|---|
| Nifty BeES | 750 | 771 | 578250 |
| Nifty put of 8000 Strike Price (Expiring in the month following the month in which dividend is likely to be declared in Nifty BeES) | 75 | 424 | 31800 |
Now let us analyse some situations and also and analyse the payouts associated with each.
1. Nifty remains at 8000:
| The payoff from Nifty BeES | (750 * 800) | 6,00,000 |
| Payoff from options | Nil | |
| Dividend received from Nifty BeES | 1% of 6,00,000 | 6,000 |
| Total amount received | 6,06,000 | |
| Total amount invested | 6,10,050 | |
| Risk (Maximum probable loss) | (6,10,050 - 6,06,000) | 4,050 |
2. Nifty remains below 8000:
In this case, also you will recover Rs 6,00,000. Part of this amount will come from the gains that the Long Put position will generate. Remaining amount will be generated by the sale of Nifty BeES at the current prices.
3. If Nifty remains above the 8000 levels
In this case, you will get unlimited profits from the appreciation of the value of the Nifty BeES. The Nifty put will expire worthlessly. However, the profits from the Nifty BeES position will compensate for the loss of premium.
This strategy is excellent for earning big returns while limiting the boxes to a minimum level. So go ahead and try this strategy while reading. If you have any question I want to understand this in depth then please get in touch with us.
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This article is for education purpose only. Kindly consult with your financial advisor before doing any kind of investment.