The following strategy can be used over any Blue-chip stock of NIFTY 50 or SENSEX 30 portfolio of index and one requires a Basic understanding of Screening Blue-chip Stocks and Monthly Option writing
Advantages of the following Strategy =>
- Removes the dilemma of perfectly timing the short-term dips
- High Probability trades with cheap returns
- 1 Trade per security in a month
Risks bound to the strategy =>
- Minimum Capital required is 5 Lakhs
- Heavy losses during Black Swan Events
As, said by experienced traders: “Option Writers eat like Ants and shit like elephants”
To mitigate the following risk =>
- Keep a daily track of the P&L and time decay gains
- Place a Stop-Loss as soon as one losses 2X of the premium received during Option Selling
Ask me any follow up questions you guys might have in the comment sections below.
- Initiate the strategy preferably at the start of the month
- Discount the current market price of the Blue-chip Stock by 2.5% and note the following strike price
- Sell the Out of The Money Put Option at the noted strike Price
- At the last Thursday of the Month (current month’s expiry), there are two possibilities:
[NOTE: OTM strike price can be also be selected using the next support or the Highest sold Multi-strike Option Interest of Put strike price but the chosen strike price should not be discounted less than 2.5%]
4.1 Spot Price > Sold Strike Price:
The current market price remains above the OTM strike price.
Exit the position and book Profits.
The profits earned can be used as cost cutting over invested security
Reinitiate the strategy for the next month.
4.2 Spot Price <Sold Strike Price
The current market price falls below the OTM strike price.
Book the loss and buy the stock back at cheaper levels.
The loss gathered from the selling option will be much less than the profits from discounted price levels of the Blue-chip stock.
Lot size is between 5 - 8 Lacks, Now a days bluechip company also going down 25- 30 % in short horizon ( Hdfc twins, Jubilant, HUL) so take a risk as per your allocation comfirtability not looking at some few rupees PE premium at initial time it looks like mouth watering but in hindsight we may end up with unwanted delivery with a not planned amount.
If you want execute this do with risk defined stoploss not at delivery cost.
Thanks for this post. How about simply buying put options as an ‘insurance’. In this case, we are not expecting any premium but only loss protection? I have been thinking about this. But unsure of what percentage of PF should go for this etc.
Assuming you dare not to lose a premium of 1 rupee per share
Buying deep OTM Put Option as a hedge would lead to the following results =>
- Will loose all your premium in case the current market price does not fall below the
Break Even level = strike Price of deep OTM PE - Premium Paid
- Thus making your investment decision a bit more more expensive by the end of the month, if you plan to execute the delivery of the underlying security.
- In case the underlying security breaks the Break-even, Implied Volatility gains will be huge and you would have turned a lottery -But the probability is extremely low
Ultimately the probability of loosing the premium will be extremely high due to time decay over the month and the strategy won’t be that effective in the long run.
Is there any backtested data for blue chip stocks as to how this strategy performed over last 1, 3 and 5 years?
Due to the following reasons, I believe that Back test results wouldn’t be much of a help:
- Above mentioned strategy is discrete and not continuous traded.
- Compounded returns are subjective to their respective CAGR returns
Dependence of Blue-chip stocks on NIFTY and Market Sentiments is extremely high
- There is no mention of squaring-off invested securities.
NOTE: Consider the above methodology as a technique to discount your investments rather than a Trading Strategy.
Thanks for the response. I was just wondering about the success of this strategy over long term as there can be big movement even in blue chip stock at-least once in a year due to news/results etc. HDFC twins would be a good example of such movement. Such movements happening couple of times a year could potentially wipe off any profits earned during entire year.
I didn’t get the “hedge” part of the title.
Regarding you strategy, it is very similar strategy as monthly covered call strategy. I have thought about similar strategy with various kind of variations. My only conclusion is that this strategy would give a considerably less returns than simply buying and holding NIFTY index, with the cash used for this F&O strategy in long term.
Just some aspects which you need to consider, if you have missed:
Buying and holding for long time gives you deferred tax for investment returns.
All profit from F&O is taxed as business income which would usually be at least 30% for individual. There is transaction charges and slippages (because stop loss doesn’t always work at the level you want) to considered. Overall, significant transaction charges which the theta decay has to overcome.
This strategy restricts the significant upmove which one could attain by simply going long in the stocks. The upmove usually isn’t smooth, most upmove happens over very short term. And if you miss the signifcant upmove of even a great stock (returning >25% CAGR in more than 5 years) would end up returning less than FD return.