What is your most successful option-trading strategy?

  • I was a little surprised when I saw this question:

    What is Pramod Kumar’s option trading strategy?

    Why someone would be interested in my strategy, assuming I have any?

    I am just one month old on Quora. In fact, I did not understand what an Upvote was or how you follow someone. I just shared few of my experiences and beliefs about trading the stocks and options and was glad that some of the readers liked what I wrote.

    So rather than answering the question highlighted above, I have chosen to reply in response to a general question.

    The answer is specific to Option Trading in Indian Stock Markets.

    My Strategy :

    If you have read any of my other answers here, it would be noticed that I am either shorting the stock futures or buying PUTS. I may be one of the few traders who rarely made any profit on the long side. What does it make me?

    A bear perhaps.

    But whatever the name, it is the successful trades that count.

    For want of a better name , I call my trading method as— KISS Method.

    Keep It Simple, Stupid.

    How Do I Keep It Simple? :

    Well, I have gone through all the jargon, studied whatever was possible, tried to make sense of so much knowledge and data available and decided that it was not worth it.

    In simple words, an option on a stock or index will go up in price when:

    The underlying price moves in that direction. ( Up for Calls and Down for Puts )

    This movement happens before expiry of contract. ( Loss in value called Time Decay )

    There should be a sudden spike favoring your trade within the expiry period. (Volatility )

    I base my trades on these simple assumptions and apply normal trading wisdom to Option Trading.

    And it works. You can read it here:

    Pramod Kumar’s answer to How big was your incurred loss in the Indian stock market? What is the main reason for that loss?

    Actually the above post is about how I recovered from the loss and made subsequent profits.

    Finding A Trade:

    I am generally looking for the stocks which are volatile and with a negative bias. I just mentioned that I mostly buy PUTS.

    Finding the right stocks to short or buying PUTS is the key strategy.

    Over the years, I might have developed some sense about catching the stocks about to fall. Or maybe I was just lucky.

    Anyway, as most analysts say, with all the analysis and algorithms at their disposal, they are successful in about 53% of trades.

    Source:

    Kirubakaran Rajendran’s answer to Is it advisable to follow stock broker’s research recommendations for trading?

    With a toss of coin also, one should get that 50% success.

    But I do a little more than flipping a coin.

    First I have a look at NIFTY stocks and see what stocks and sectors are not doing well.

    How is their price movement compared with Nifty Index. ( So called Beta, I am looking for high beta )?

    Is the company facing a highly competitive / regulated market?

    How is the company perceived in the market compared to its peers. ( It is a fundamental analysis issue, but I just make a note of it )

    Did the stock run up recently just on some news, business environment remaining the same?

    Same logic for some other large caps not in the Nifty Index.

    Based on the above simple question, I have my list of stocks ready. Very rarely, I make a trade other than in these stocks.

    I will share some of these names:

    Reliance Communication

    Reliance Infra

    Reliance Capital

    BHEL

    Canara Bank

    State Bank Of India

    Tata Steel

    ICICI Bank

    And of course NIFTY.

    What After Buying The Puts?:

    Mostly I buy slightly Out Of Money Put. Sometime I may buy a Put at about 5–8% away strike price.

    Example:

    This month, I bought Canara Bank 300 PUT ( 29 December Expiry ) when the stock price was Rs. 309. Bought it for Rs. 10.65. Saw the price going up slowly and time decay causing the value go down to Rs. 3.90.

    Then came the volatility play in the week 19–23 December.

    Sold for Rs. 17.10 on 23–12–16 when the price came down to 284.

    Bought 2 lots of 280 PUT at 3.80 and 3.90 ( Slightly out of money )

    Sold 1 lot for Rs. 5.30 on same day.

    More volatility on Monday due to Prime Minister’s statement regarding taxing the market players caused Canara Bank to go further down on 26–12–16. I exited the remaining one lot for Rs. 11.00.

    And by my normal patience standards, these trades were bit hurried. I would generally wait and the one lot of 300 PUT alone would have sold for about Rs. 35–36 when the stock price touched 264/263 on Monday 26–12–16. Profit realized would have been much more and trades few less.

    Anyway, the trade is over and gave over Rs. 45000 in profit.

    Maximize the Gains When Market Favors.

    I did not do it this time, but most of the time I follow the above principle. When the market reverses, it takes away some of the gains, but you have to wait to find out where you could have gone.

    The wait is always full of suspense, at times painful. But it has to be endured. You do not get to enter the gates of heaven without meeting death. Waiting has its own sweet reward.

    I have seen cases, where option price has gone up 8–10 times in a week’s time, sometimes in one trading session only. I have taken a maximum profit of 12 times in one of my trades. Twice to Four times is quite reasonable with some patience. See the Canara Bank example above.

    When Price Moves Away From Me? :

    Okay. I accept that the trade was wrong and take the loss.

    I think the experts told you they are right about 53% of the time. I am also right around same percentage.

    When right, my profit is more that 100% of the premium paid.

    When wrong, it is 100% of the premium paid. At times, I salvage something out of these, so the loss is at about 90%.

    So it works.

    The key is in selection of the stocks and waiting when the price moves for you.

    The KISS Summary:

    Select a list of Volatile Stocks

    Ensure that there is enough trading volume in the OTM options

    Buy Puts or Calls depending upon your assessment of the price trend

    With proper selection and following the trend, you will be right in about half the trades.

    Wait in Profit. Options can give Unlimited Profit.

    Stay in the trade to take that. Try to get more than 100% on a winning trade.

    Take the losses sportingly.

    Profit is waiting in the next trade.

    Will It Work For You? :

    It works for me.

    Should work for anyone else too.

    No formulas or rocket science is involved. No jargon either.

    Only requirement is the patience to wait for maximizing the profits in the successful trade.

    Develop patience. Patience Pays.

    Let the KISS method work magic for you.

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