EspressoLogy

Rule Base Expiry Day Option Trading

In this world, nothing can be said to be certain, except death, taxes, and theta decay.

Theta decay will always happen and continue to happen, That's why selling options will have a high probability of winning.

Though it's a riskier Instrument to trade, with proper risk management you can avoid huge losses and that's why maximum people are inclined toward option selling.

In this I am going to explain how a simple strategy can make wonders in the long term and with small tweaks in that strategies can Improve performance drastically.

Let me explain, we all know that there are a ton of option selling strategies in the market and people are using them. Let's take an example

9:30 am Option selling strategy

1) Instrument: Bank Nifty Options

2) Days: Everyday

3) Expiry: Weekly Expiry

4) Entry Selection

5) Time: 9:30 A.M

6) Strike Price Selection: Select the First CE/PE strike which is greater than 100

7) Entry Criteria Sell CE and PE

  Example :

    CE  Trading at @103 so we will Short CE at 103

    PE Trading at @105 so we will Short CE @105

8) Stop Loss: 30% of the entry price as and when the order is triggered

   Example :

   CE selling price at 103 then we put stop loss at 133.9 ( 30% above Entry Price).

   PE selling price at 105 and we put stop loss at 136.5 (30% above Entry Price).

So If we backtest this simple strategy from Jan 2016 - to April 2022 with this rule we will get respective statistics.

Month wise Profit and Loss :

Statistics:

Equity curve:

You can observe from the above stats that before that let me explain what are the main parameters you observe after backtesting.

You can observe from the above stats that before that let me explain what are the main parameters you observe after backtesting.

1. Calmar Ratio

    Formula Calmar Ratio = Average Return / Maximum Drawdown

    The higher the Calmar the better is your system.

2. Maximum Drawdown

    Try to have a less DD system because you have to trade this strategy for the long term so that it will not affect your   psychology.

Other parameters you can observe from the above table.

Now what I will try to do is simply change some rules so that we can increase the performance of the strategy.

What we are going to do is change the entry criteria to wait and trade, It simply means that

Suppose the current market price of CE and PE is 100 then we will put SL order 10% below the price which is 90 and we are going to sell them at 90 rupees.

Given below are The modified rules.

Modified Rules for Option selling strategy for better performance.

    1) Instrument: Bank Nifty Options.

    2) Days: Everyday

    3) Expiry: Weekly Expiry

    4) Entry Selection Time: 9:30 A.M

    5) Strike Price Selection: Select CE & PE trading just Above 100

    6) Entry Criteria Put 10% Stop Loss Below Current Market price at 9:30 am

        Example:

        CE  Trading at @103 so we will put a Short Stop Loss order for Entry at 92.7 ( 10% Below 103) till EOD.

        PE Trading at @105 so we will put shot Stop Loss order  for Entry at 94.5 (10% below 105) till EOD.

    7) Stop Loss: 30% of the entry price as and when the order is triggered

      Example :

      CE Triggered at 92.7 then we put stop loss at 120.5 ( 30% above Entry Price).

      PE triggered at 94.5 and we put stop loss at 136.5 (30%  above Entry Price).

    8) Exit: We close at 3:20 PM or Stop loss triggers whichever is earlier.

 Let's check the backtested stats for these modified rules.

 Below are the performances for rules of strategies after removing slippages.

In this, the main factor we will take into consideration is the CALMAR ratio and DD

1. What we can observe is that we reduced the DD from 558.76 to 432 which is quite a good result.
2. Calmar ratio Increases which indicates that either DD reduces or return increases. (Higher Calmar indicates a good system)

If you ask any good trader,

These are our rules and we get these statistics from both of them which one you will trade.

His answer will most likely be the 2nd one.

Reasons

1. He wants to trade that strategy for the long term so most probably he would look for fewer DD systems.
2. Calmar is higher
3. The average loss is less as compared to the first one.

So simply waiting for the price to fall 10% and then sell, improve the system drastically.

Always remember other ways to improve these strategies are

• Time Diversification
• Percentage Entry Criteria to safeguard the returns
• Trade the Support and Resistance Levels
• Trailing the stop loss

 Click here to see the video on same.

Disclaimer: Investment in securities market are subject to market risks. Read all the related documents carefully before investing. Please refer the Risk Disclosure Document issued by SEBI and go through the Rights and Obligations and Do’s and Dont’s issued by Stock Exchanges and Depositories before trading on the Stock Exchanges. Brokerage will not exceed the Exchange prescribed limit.