Use historical ranges as an advantage to trade short straddles
Straddles are quite popular in the derivative trading community. The short straddles have become an order of the day because of their suitability. It is categorised as a limited return and unlimited risk but if asked genuinely, there is no relevance to the risk. The risk is very minimal for anyone who understands the calculation of the risk-reward ratio and the break-even levels.
As the trading volumes in options segment has increased multifold, particularly in indices, the premiums became expensive at the beginning of the week. The weekly option has the advantage of Theta (time value) erosion and one can take advantage by using the high premiums as tools to build the straddle. At the beginning of the week, at-the-money (ATM) calls and puts premiums’ combined value together ranges anywhere between Rs 1,100 and Rs 1,400. This means you are fortunate even if Bank Nifty moves 1,100-1,400 points on either side.
Historically, over 70 per cent of the time on a weekly basis, Bank Nifty moves less than a thousand points. However, there are some exceptions for highly trending market like recent post-budget move or a Sitharaman candle, where the market was highly trending. If you can understand this historical range, it is highly profitable. In such extraordinary conditions, adjust the option strategy accordingly.
According to history, the market trend only about 30 per cent of the time and the remaining 70 per cent moves in a range. Use this historical fact as an advantage and apply short straddles for profitable trading. You can adjust the short straddle into strangle at a later stage by exiting the profitable position and hedge the loss-making option. In a normal course of action, exiting a profitable position is a bad idea. In this case, one can exit a profitable position when the option premium enters into a single digit. So, even if you hold this position, you may not get much return. In such cases, we exit this profitable position and hedge the loss-making by selling another option, i.e., at-the-money (ATM) mostly.
For example, during the weekly expiry (February 26 to March 04), Bank Nifty moved in the range of 1,796 points. At the beginning of the weekly option series, the ATM of 35,800 call premium was Rs 625. The 35,800 put premium was at Rs 466.60. Selling these two options means applying a short straddle and you end up receiving a total premium of Rs 1,091.60. At the end of the series, the put premium fell to Rs 17.50, and the call premium declined to Rs 16.90. The short straddle ends at Rs 34.40. You made a profit of Rs 1,056.20 multiple lot size of Bank Nifty; the profit is equal to Rs 26,405. Isn’t it amazing?!