Trading Strategy Case Study #4
Aim: Earning alpha using Government Securities and Index Options
Mechanism: The scope of the strategy is to use Government Securities as collateral and using them as margin, sell index options (NIFTY) to generate alpha. The strategy is commonly called a “Short Strangle” options strategy.
- Buy Government Securities worth Rs. 1,00,000. Roughly, the yield is around 7.5% currently.
- Pledge them to get margin. With 10% haircut, you will get a margin of around Rs. 90,000
- Now sell lower strike put option and upper strike call option in NIFTY to get premium.
Follow the below mentioned calculation to identify the strikes.
|ROI Required (A)||15.00%|
|Additional Return (A-B)||7.50%|
|Additional Return in Amount (C)||7,500.00|
Now either go for weekly, monthly or long term based on the premium needed and choose the strikes.
For weekly, we need a premium of Rs. 156.25. As NIFTY lot size is 50, we need the straddle premium of Rs. 156.25/50 = Rs. 3.13. Now go to the option chain to select the strikes such that the total strangle premium is equal to Rs. 3.13.
Similarly for monthly, the strangle premium = Rs. 625/50 = Rs. 12.5 and for annual, the strangle premium = Rs. 7500/50 = Rs. 150
As you can see from the payoff graphs that the range is too wide to get breached (black swan events are exceptions). So you will consistently make a gain of 15% if you follow this with discipline. Based on your risk profile and return expectations, you can adjust your calculations.
Insights: In PTDs, such strategies are deployed on a large scale (around 1000-2000 lots each desk). However, as the strangle strategy carries unlimited downside risk, a strict SL of thrice the option value is placed as SL which helps to protect from any black swan events. The same can be followed as a measure of protection.