Strangle Adjustment : Nifty Feb 2020 series

Strangle payoff

Introduction

Strangle is one of the most popular trading strategies for option sellers. It tries to capture the underlying within a range by expiry. If that happens, traders profits from both call & put side of the trade. Strangles have a high probability of profit given it allows ample opportunity for trade adjustment in case underlying starts moving violently in a particular direction. As an option seller, knowing how to adjust a strangle is one of the most critical things on the path to sustainable profit.

I am starting this blog to teach a well defined system to adjust a strangle. It is important that a trader knows what to do in each scenario. Each rule should be defined as objectively as possible so that when the time of decision comes, there is no scope for emotions to play any role. I will be trading in Nifty options for 27 Feb expiry. Instead of posting my entire system of strangle adjustment at once, I will keep posting each rule one by one as I use them to adjust my position. This will be a better way to learn as all of you will be learning from real life examples.

For effective learning, I would need support from all the readers to come with questions and ask them without any hesitation. If any of the concepts are not clear, I can write specifically on that rule in more detail in a separate blog.

I will be adding trade logs, rules and crisp logical reasoning after the market closes each day. Each day’s content will be appended below so that we have one place for all our learning. I will start trading sometime this week, once the volatility due to budget and corona virus settles a little.

Please subscribe to this blog and follow me on twitter to get all the latest updates.

Context

  • I will be trading Nifty options of 27 Feb 2020 expiry.
  • I will be using a capital of 6L . This allows me to sell 6 lots of Nifty. 
  • All my positions will be overnight and hence I would not be using any intraday margin. Exception may happen on 27 Feb which is the expiry day.
  • I will keep my capital in Liquidbees and will use that as collateral. This allows me to get fixed monthly returns in form of dividend irrespective of how my strangle does.
  • I will not use all 6 lots at once to setup the strangle. I will use a few to start with and keep remaining for adjustments later. Details will be explained as I take the trade.
  • I will not carry any naked short position overnight. I will always hedge it by buying an option, no matter how OTM. Every option seller should be aware of the risks associated with naked options selling.
  • My strangle adjustment rules rely a lot on an options greek delta. No need to go mathematical. You just need to know the delta value of an option. I will be using the free option chain provided by Sensibull to know the delta of any strike price. If you want to dig deeper, I have explained about delta in this post.
  • I will exit all positions If my loss reaches 2% (Rs. 12000) of my capital.

Trade close summary

Feb proved to be a challenging month for playing strangle. Nifty was all over the place, resulting in strangle getting hit at both the call side and the put side. There were multiple gap openings which made adjustments ineffective.

I set up the strangle when Nifty was at ~11850. In a couple of days, Nifty rallied ~400 points to ~12250. In the next couple of days, Nifty fell ~350 points to ~11900. Next day Nifty opened ~100 point gap up and rallied till ~12150. It consolidated a bit around 12100 , but then again started falling. Nifty opened 100 point gap down and fell ~250 points in a day to 11850. All this was too much for strangle or any adjustment to bear. The SL got hit, and I came out of the trade before losses turned big.

I will write my learning below. Hopefully It will also be helpful for all the strangle traders.

What went good

  • I was able to follow my system with discipline for all days except one.
  • System did withstand a couple of up and down rallies before SL got hit. 
  • I could exit my trade in 2.5% of capital loss, which could have been much bigger given how volatile the markets are.

What went bad

  • After so much effort, I had to take losses in the end.
  • On Day 7 , I had a choice between 11900PE at 0.17 delta and 11850PE at 0.13 delta. Both could have made position delta neutral, but 11900Pe was making the deltas exactly 0. So I chose to sell 3 lots of 11900PE. The markets reversed sharply and the call side had to be brought much closer to the ATM strike to balance deltas. Ultimately I had to exit the put side in loss. The markets reversed sharply again, this time leading to loss exit on the call side. Choosing 11900PE over 11850PE proved to be a turning point of the trade. 11850PE would have bought more time saving some loss exits. This makes me realise that I should always choose 0.16 delta or lesser option for adjustment whenever possible.
  • On Day 14, I could not monitor my position due to some work. This led to small losses getting bigger and my SL got hit. If I would have taken adjustment early on, I would still be in the trade. Though looking at the market, it might not have been a profitable month, but losses could have been lesser.

Where did I get lucky

  • On Day 12, I forgot to buy risk management on the put side. I ultimately bought it the next day. But any market crash overnight had the potential of unlimited losses. I am lucky that it did not happen.
  • On Day 14, I did not close my position even when SL of 2% got hit. Emotions took control over logic. I realised the mistake and closed all my trades on Day 15. The losses could have been much bigger if there would have been another gap down opening on Day 15. I am lucky that it did not happen.

=================================

Day 15 : 25 Feb

Nifty did not recover on the market open. Closed all trades as SL got hit. Net loss is ~2.5% of my capital employed.

Market close summary 

Net Realized P&L for Feb : -14,846 (~2.5% of capital)

P&L for 25 Feb
P&L for 25 Feb

Day 14 : 24 Feb

Due to some important work, I could not monitor markets and take adjustments. By the time I looked at Nifty, it had already fallen below 11900. Emotions took control over logic and I delayed taking adjustments in hope of recovery. Nifty ended the day with 250 points fall. MTM has crossed 16K which is more than the loss I can afford to take. If the market does not recover at open tomorrow, I will close all my positions in whatever loss the market offers.

Market close summary

Realized P&L for the day : 0

Realized P&L for Feb : -442.5

MTM : -16091.25

P&L for 24 Feb
P&L for 24 Feb

Day 13 : 20 Feb

Nifty consolidated around 12125 for most part of the day and ended in red due to fall towards market close. Finally a day with some relief. No adjustments taken as delta neutrality stood its fort. MTM is very green for the first time.

Bought 2 lots of 11300PE for risk management which I forgot to buy yesterday.

Market close summary

Realized P&L for the day : 0

Realized P&L for Feb : -442.5

MTM : +1020

P&L for 20 Feb
P&L for 20 Feb

Day 12 : 19 Feb

Nifty opened a gap up by ~100 points. Call side suddenly came in danger. Had to make a loss exit to make the position delta neutral. For the first time, realized P&L went negative. Feb series is getting really challenging. Nifty is moving 200-300 points in matter of days and giving sharp reversals. Forget profits, If we can manage to get out of these days in small losses, it should be an achievement. If we can cut our losses when they are small, we stand a good chance to recover from them using profits when the right time comes.

Trade 1

Nifty was at 12900 at ~9:17AM . Position deltas were:

11900PE : 1 x 0.20

12200CE : 1 x -0.30

12250CE : 2 x -0.23

Average position delta = (0.2 – 0.3 -0.46)/4 = 0.14 which is much greater than 0.075.

Position desperately needs an adjustment.

How to do adjustment ?

I looked at the option chain and 11850PE was at 0.15 delta. I have 2 lots available. To balance delta, i used both the lots to sell 11850PE. My new position delta was not close to zero but the average position delta was less than 0.075.

Sell 2 lot 11850PE

Deltas looked as follows.

11850PE : 2 x 0.15

11900PE : 1 x 0.20

12200CE : 1 x -0.30

12250CE : 2 x -0.23

Average position delta = (0.3 + 0.2 – 0.3 – 0.46)/6 = 0.26/6 = ~0.045

New position delta is still not very neutral. As a better measure, I could also have chosen to sell 0.2 delta options on the put side, but I was not comfortable with that risk as I just yesterday exited 11900PE in loss. I did not know, If this bull market will stay for long or will suddenly reverse.

Where is the risk management for 11850PE ?

I placed a limit order to buy 2 lots of 11300PE. The limit order never got executed and I forgot to check before the market closed. This is a big mistake on my side as I have kept a naked short position overnight. I hope the world markets does not crash tomorrow, and I will buy the hedge first thing in the morning tomorrow.

Trade 2

Barely 15 minutes into 1st adjustment, Nifty rallied to ~12115 at 9:30 AM. Position was already skewed as delta were not perfectly neutralised. I had to finally take another adjustment to prevent the call side from hurting. Position delta looked as follows.

11850PE : 2 x 0.12

11900PE : 1 x 0.16

12200CE : 1 x -0.36

12250CE : 2 x -0.27

Average position delta = (0.24 + 0.16 – 0.36 – 0.54)/6 = 0.5/6 = ~0.8 . Since it is greater than 0.075, the position needs to be adjusted.

How to do adjustment ?

Call side is heavily dominating with 0.9 delta. Even if i sell 3 lots of 0.2 delta option, I will not be able to delta neutralise the position properly. So I decided to exit the 12200CE in loss.

Exit 1 lot 12200CE in loss

Exit 1 lot of 12850CE which was for risk management

Position delta were finally properly neutralised.

11850PE : 2 x 0.12

11900PE : 1 x 0.16

12250CE : 2 x -0.27

Average position delta = (0.24 + 0.16 – 0.54)/5 = ~0.03 , which is less than 0.075

P&L on this adjustment looks as follows.

Loss on 12850CE  = 30

Loss on 12200CE = 1383.75

Net P&L = -1413.75

Market close summary

Today really took a toll on my emotions. It is always hard to  exit a position in loss and today my net realized P&L for Feb went negative. The positive thing is, even after such gap ups, my net loss is just a minor percentage of my capital.

Realized P&L for the day : -1413.75

Realized P&L for Feb : -442.5

MTM : -3573.75

P&L for 19 Feb
P&L for 19 Feb

Day 11 : 18 Feb

Nifty was all over the place today. Opened at ~12040, it fell to ~11910 during the first half. I had sold 3 lots of 11900PE. 2 of them were squeezed out in loss. Thankfully earlier profits were able to cover all the loss. Adding to the misery, Nifty started rallying in the last hour, touched 12000 again and closed at ~11990. The trade adjustments taken today are explained below.

Trade 1

At 9:30AM, Nifty was at ~11965. My position deltas looked as below

11900PE : 3 x 0.38

12200CE : 1 x -0.18

12350CE : 2 x -0.08

Average position delta = (1.16 – 0.18 – 0.16)/6 = 0.72/6 = 0.12 , which is higher than 0.075, hence adjustment is needed.

How to do adjustment ?

Put side is at a huge delta of 1.16 . I cannot balance this by selling just ~0.15 delta options on the call side. This is a desperate situation as I might have to exit my put side in loss. In such a situation I can consider selling upto 0.2 delta options on the call side. But even if I try to sell 0.2 delta options on the call side, the position cannot be delta neutralised. Hence the only way out is to exit 1 lot of put option taking some losses. 12250CE was at 0.14 delta. To get enough delta on the call side, I rolled 12350CE to 12250 strike price. Also I exited 11400PE which was kept for risk management of 11900PE. Hence I placed the following orders.

Exit 1 lot 11900PE in loss

Exit 2 lot 12350CE in profit

Sell 2 lot 12250CE

Exit 1 lot 11400PE which was kept for risk management.

My new position deltas looked as follows.

11900PE : 2 x 0.38

12200CE : 1 x -0.18

12250CE : 2 x -0.14

Average position delta = (0.76 – 0.18 – 0.28)/5 = 0.3/5 = 0.06 , which is less than 0.075

My P&L on this adjustment looked as follows.

Loss on 11900PE = 75*(73.05 – 30.8) = 3168.75

Profit on 11400PE = 75*(8.6 – 7.5) = 82.5

Profit on 12350CE = 806.25

Net P&L = -2280

Trade 2

Nifty kept falling. At ~11:15AM , Nifty was at ~11935. 11900PE is in super danger. The position deltas looked like the following.

11900PE : 2 x 0.41

12200CE : 1 x -0.16

12250CE : 2 x -0.12

Average position delta = (0.82 – 0.16 – 0.24)/5 = 0.42/5 = 0.0805, which is greater than 0.075. Hence we need to make an adjustment.

How to do adjustment ?

My put side delta is 0.82. Even if I sell 3 lot of 12200CE which is at 0.16 delta, I cannot delta neutralise the position. Out of desperation to save on taking losses, I can consider selling upto 0.2 delta option. But the next strike price 12150CE is at 0.21 delta, which is outside my risk comfort zone as it is greater than 0.2 delta. Hence the only choice left is to exit one more 11900PE taking some losses. Also, I exited one lot of 11400PE as it was used as risk management for 11900PE. I placed the following orders.

Exit 1 lot 11900PE in loss

Exit 1 lot 11400PE which was kept for risk management.

My new position delta looked as follows.

11900PE : 1 x 0.41

12200CE : 1 x -0.16

12250CE : 2 x -0.12

Average position delta = (0.41 – 0.16 – 0.24)/4 = ~0

My P&L on this adjustment looked as follows.

Loss on 11900PE = 75*(73.90 – 30.8) = 3232.5

Profit on 11400PE = 75*(7.5 – 7.4) = 7.5

Net P&L = -3225

Market close summary

The position suffered a loss of -5505, but all of this was compensated from the profits earned earlier. This is the power of adjustments we take. Days like these will happen in the market, and we cannot predict them. Through adjustments, we can ensure that the losses are compensated from the profits earned. We still have 6 trading days, and theta decay is getting on our side as we near the expiry. If the market does not give any more violent movements, we can pocket profits from the remaining premium and even more as we make more adjustments.

Realized P&L for the day : -5505

Realized P&L for Feb : +971.25

MTM : -7515

P&L for 18 Feb
P&L for 18 Feb

Day 10 : 17 Feb

Nifty had a volatile day today. Made a day high of 12160 during market open and ended the day at ~12045, with ups and downs in between. The call side sighed a big relief with 12200CE now being ~150 points away. The put side came in a little danger with Nifty continuously falling. Took an adjustment to balance the deltas on both sides.

Trade 1

Nifty was at ~12070 at ~12:50PM. The deltas of position looked as follows.

11900PE : 3 x 0.26

12200CE :  -1 x 0.30

12400CE :- 1 x 0.09

Average position delta = (0.78 – 0.3 – 0.09)/5 = 0.39/5 = 0.078 which is >= 0.075 This means that we need to do an adjustment.

How to do adjustment ?

Put side delta being at 0.78 is dominating the call side delta which is at 0.39. Hence we need to sell ~0.15 delta option(s) on the call side. I have already used 5 lots out of 6 available lots. So I can sell just 1 more lot on the call side to make the position close to delta neutral. I looked at the option chain and found that 11350CE was at 0.13 delta and 11300CE was at 0.18 delta. Keeping my rule of selling close to 0.15 delta options, I chose to use 11350CE to delta neutralise the position. 12400CE was in profit and delta had come down to 0.09. So I decided to exit 12400CE locking in some profits and roll it to 12350 strike price which was at 0.13 delta. I used my last remaining lot by selling one more 12300CE to increase the overall delta on the call side. I took the following trade.

Exit 1 lot 12400CE in profit

Sell 2 lots 12350CE

Buy 1 lot 12850CE for risk management

My new position deltas looked like the following.

11900PE : 3 x 0.26

12200CE : -1 x 0.30

12350CE : -2 x 0.13

Average position delta  = (0.78 – 0.30 – 0.26)/6 = 0.22/6 = ~0.037, which is less than 0.075.

Why entered a full capacity strangle ?

To refresh the memory, a full capacity strangle is one where all the available lots are used in the position. The bad thing about full capacity strangle is no more lots are available for doing any adjustments. The only way to delta neutralise the position is rolling the options on the profit side or exiting the losing side options in loss. This is not a comfortable situation to be in. But we had no other choice left. With Nifty down to 12070, put side delta were dominating at 0.78. This cannot be managed by just 2 options on the call side without taking risk of selling much more than 0.15 delta options. So I sold the last available lot and entered a full capacity strangle.

Market close summary

Realized P&L for the day : +401.25

Realized P&L for Feb : +6476.25

MTM : -3708.75

P&L for 17 Feb
P&L for 17 Feb

Day 9 : 14 Feb <3

Nifty gave violent movements today. It ended up in red at ~12110. Much relief for the call side. But to prevent danger on the put side I took an adjustment.

Trade 1

Nifty fell to 12210. My position delta looked as follows.

11900PE : 3 x 0.24 = 0.72

12200CE : 1 x -0.36 = -0.36

Number of lots sold = 4

Average position delta = (0.72 – 0.36)/4 = 0.36/4 = 0.09 which is greater than 0.075

Time for adjustment has arrived again.

How to do adjustment ?

Put side is dominating as its delta is 0.72 which is much greater than 0.36. This means I need to balance the deltas on both the sides by selling more option(s) on the call side. I looked at the option chain and found that 12400CE was at 0.15 delta. Hence, I sold 1 lot of 12400CE to make the position delta neutral.

Sell 1 lot of 12400CE

But 1 lot of 12700CE for risk management

My new position looked like the following.

11900PE : 3 x 0.24 = 0.72

12200CE : 1 x -0.36 = -0.36

12400CE : 1 x -0.15 = -0.15

Number of lots sold = 5

Average position delta = (0.72 – 0.36 – 0.13)/5 = 0.23/5 = 0.046 which is less than 0.075

Why not sell 2 lots of 12400CE ?

Put delta is at 0.72 and call delta is at -0.36. Difference between delta is 0.36. So we could have sold 2 lots of 12400CE (0.13 x 2 delta) as we have capital of 2 more lots and that would have made position more delta neutral as compared to selling just 1 lot of 12400CE .

I still did not sell 2 lots, instead I chose to sold only 1 lot of 12400CE. Reason is I want to avoid a full capacity strangle. Now what is full capacity strangle ? A full capacity strangle is a strangle where all available lots are used. If I have used all available lots, there are no more lots available for adjustment in case the market decides to move violently. So I would try to avoid a full capacity strangle whenever I can. Hence I used just 1 lot of 12400CE. This way, though I sacrificed some delta neutrality, I did not make a full capacity strangle. My new position delta is still below 0.075 as governed by the formula.

If the market keeps falling and there is no other way for adjustment, then only I will enter a full capacity strangle.

Market close summary

Realized P&L for the day : 0

Realized P&L for Feb : +6075

MTM : -4556.25

P&L for 14 Feb
P&L for 14 Feb

Day 8 : 13 Feb

Nifty consolidated for the whole day and ended up in red. Call side is again Out of the Money but still not out of danger. No trade adjustments taken as delta neutrality was not broken as per the formula. This is how deltas look at market close.

11900PE : 3 x 0.19 = 0.57

12200CE : 1 x -0.45 = -0.45

Net delta = 0.57 – 0.45 = 0.12

Average position delta = 0.12/4 = 0.03 which is less than 0.075. Hence no adjustment is needed. 

Market close summary

Realized P&L for the day : 0

Realized P&L for Feb : +6075

MTM : -5227.50

P&L for 13 Feb

Day 7 : 12 Feb

Nifty touched 12200 within 15min of the market open. 12200CE is now in the money, which is not a good thing for  me as an option seller. Made an adjustment which I will explain below. 

Trade 1

At around 9:30AM, Nifty was at ~12200. As per the formula, the average position delta looked like the following:

12200CE : -1×0.51

11500PE :   1×0.04

11650PE :   2×0.07

Net delta = -0.51 + 0.04 + 0.14 = -0.33

Number of lots sold = 4

Average delta = 0.33/4 = 0.0825 which is greater than 0.075

Hence time for adjustment has arrived.

How to do adjustment ?

As per the option chain, 11850PE was at 0.13 delta & 11900PE was at 0.17 delta. Since there is no 0.15 delta option on the put side, I have to choose among these two. 12200CE was at 0.51 delta. If I sell 3 lots of 11900PE, my put side delta becomes 3×0.17 = 0.51 , which matches exactly with my call side delta. Though it is a little more riskier than 11850PE, still I chose that as it perfectly delta neutralizes my position, without going too far away from 0.15 delta. So I need just 3 lots of 11900PE on the put side to make my position delta neutral.

I exited all my current positions on the put side in profit. 11500PE gave a profit of Rs. 2250 and 11650PE gave a profit of Rs. 3,555. I also exited their hedge as they were not useful anymore. They were too far from my new 11900PE. I sold 3 lots of 11900PE. I also bought 3 lots of 11400PE (500 points away from 11900PE) for risk management.

Exited the 1 lot of 11500 PE.

Exited the 2 lots of 11650PE 

Exited hedge at 10800PE, 11000PE & 11150PE

Sell 3 lots of 11900PE

Buy 3 lots of 11400PE for risk management

I locked in profit of Rs. 4766.25 for the day. But my overall position is in much less profit because 1200CE is in super danger. Since the loss on the call side is not realized yet, a reversal in the market could lead to handsome profits. But if the market keeps on trending, I would have to exit the call side in loss. But I do not expect any significant loss in overall position, as my put side will keep on locking in profits. This is the power of adjustment. If the market cools off, the profits are handsome as both call side and the put side gives profit. But if the market keeps on trending, profits on one side compensates for the losses on the other side. So you end up losing a little or maybe even gaining on the overall trade. 

Why not exit 12200CE ?

I understand that 12200CE is making big losses and it may seem that we should exit it since it is now ITM. As per my trading system, I will keep firefighting by making adjustments as long as I can achieve delta neutrality by selling no more than 0.2 delta options on the put side. If even 0.2 delta option cannot make my position delta neutral, I will exit the call side in loss. This gives me enough time to wait for the market to reverse. But if the  market does not cool off, I will exit the call side and not take bigger risks on the put side. Remember the more delta of an option, more are the chance of it going ITM. If I am selling more than 0.2 delta options on the put side, my losing chance on the put side also increases to more than 20%, which I am not comfortable with. Each trader can have a different threshold for delta based on their risk appetite.

Market close summary

Realized P&L for the day : +4766.25

Realized P&L for Feb : +6075

MTM : -1222.50

P&L for 12 Feb
P&L for 12 Feb

Day 6 : 11 Feb

Nifty rallied 100+ points putting my call side in danger. Delta neutrality was about to be broken but then it started reversing a little. Trade adjustment was not required as my average position delta always remained less than 0.075. First time ended the day with MTM in green. 

Market close summary

Realized P&L for the day : 0

Realized P&L for Feb : +1308.75

MTM : +56.25

P&L for 11 Feb
P&L for 11 Feb

Day 5 : 10 Feb

Another day of little activity. Nifty fell a little and then consolidated in a range. Call side showing more mercy though still in danger. No adjustments taken today as the average position delta never became more than 0.075. To refresh the memory, I will show again how to calculate it based on market close data.

1 lot of 11500PE : 1*0.08 = 0.08

2 lot of 11650PE : 2*0.14 = 0.28

1 lot of 12200CE : 1*-0.31 = -0.31

Net delta = 0.08 + 0.28 – 0.31 = 0.05

Total lots sold = 4

Average position delta = 0.05/4 = 0.0125 which is less than 0.075. Hence no adjustments needed.

Market close summary

Realized P&L for the day : 0

Realized P&L for Feb : +1308.75

MTM : -127.5

P&L for 10 Feb
P&L for 10 Feb

Day 4 : 7 Feb

Nifty consolidated around 12100. Call side showed some mercy for now. No adjustments were needed today. Best day for a Strangle writer is when nothing needs to be done. Ate some theta decay and brought down MTM loss.

Why is it critical to have Stop Loss Market orders ?

No adjustment lesson for today, but I have an important thing to share related to risk management. We have taken far OTM options as hedge but we hope that we do not have to ever use them. Instead our stop loss should get triggered much before so that we do not lose more than 2% on any trade. 

To minimise losses, it is very important to have Stop Loss Market order in place. In case there is a sudden violent move in any direction and we are unable to perform adjustments for whatever reason (Poor internet, broker being down, personal emergency) , our stop loss order will save us. Below is the screenshot of my stop loss orders.

How to choose SL trigger price ?

My SL trigger on each option is such that I do not lose more than 2% in case of sudden violent move. 2% of my capital is Rs. 12,000 . I will set SL trigger such that my maximum loss on both call & put side is not more than Rs. 12,000.

If you see my call side, I have 1 lot sold. 1 Lot has 75 units of Nifty. This means, I can afford an increase of 12000/75 = Rs. 160 in the premium of the call side. My entry price for call option was Rs. ~35 . So my SL trigger should be no more than 195 (160 + 35) . If you see, I have placed a trigger at 180 for 12200CE.

If you see my put side, I have 3 lots sold. 3 Lots has 225 units of Nifty. This means, I can afford an increase of 12000/225 = Rs. 53 in the premium of the put side. My entry price for all the put options was around Rs. 37 . So my SL trigger should be no more than 90 (53 + 37) . If you see, I have placed a trigger at Rs. 75 for 11500PE and at Rs. 90 for 11650PE.

I am repeating this again, It is very important to cut down on loses. If losses are small, profits will be able to compensate for them. Big losses were small at some point of time. So we need to take all measures to prevent big losses. Stop Loss market order is a free service provided by exchange to take one such measure. Always put SL trigger as per your risk appetite. 

Note: SL orders get automatically cancelled by exchange after market close. Traders have to put new SL orders each day. Do not forget to place these orders everyday when the market opens.

Market close summary

Realized P&L for the day : 0

Realized P&L for Feb : +1308.75

MTM : -915

P&L for 7 Feb
P&L for 7 Feb

Day 3 : 6 Feb

Nifty remained in the range of 12100 – 12150. No adjustment required. Took just one trade to hedge for the RBI policy announcement.

Trade 1

Buy 1 lot of 12200CE 6 Feb expiry

This trade is not part of any adjustment. My call side is already in danger. So I bought a cheap weekly expiry option as a hedge for the RBI policy announcement. In case Nifty rallied, this option would have protected my losses. Nothing happened and the option expired worthless. Had a loss of Rs. 405 but worth the peace of mind.

Market close summary

Realized P&L for the day : -405

Realized P&L for Feb : +1308.75

MTM : -3015

P&L for 6 Feb
P&L for 6 Feb

Day 2 : 5 Feb

Trade 1

Nifty consolidated around 12025 for most part of the day. In the last 1.5 hour it kept rallying till 12090. Nifty closed with 110 point rally which is not an average move in such a diversified index. Call side again came into trouble and I had to make another adjustment to delta neutralise my position.

Why do I need to adjust ?

At 1:55PM, Nifty was at ~12085, my position delta looked like following:

11350PE : 0.06 x 1

11500PE : 0.09 x 1

12200CE: -0.39 x 1

Net delta = 0.06 + 0.09 – 0.39 = -0.25

Average position delta = (Absolute value of net delta)/(Number of lots sold) = 0.25/3 = 0.0833

Since Average position delta >= 0.075 , it is time to make an adjustment.

How to do adjustment ?

Out of 6 lots, I have 3 more lots available to sell. Hence I can adjust my position by selling more lots on the winning side that is the put side. If I have more lots to sell, I will try to adjust my position by selling options with ~0.15 delta. I will not prefer higher delta options, because I want to keep the winning probability of each side close to 85%. I checked the option chain and found that 11650PE was at 0.15 delta. So I took the following trade:

Exit 1 lot of 11350PE in profit

Sell 2 lots of 11650PE 

Buy 1 lot of 11150PE for risk management

This is how the new delta of my position looks:

11500PE : 0.09 x 1

11650PE : 0.15 x 2

12200CE : -0.39 x 1

Net delta = 0.09 + (0.15 x2) – 0.39 = 0

Effectively, I rolled my 11350PE to 11650PE and locked down some profit. I sold another 11650PE to completely delta neutralise the position. So we see that I was able to neutralise my position with no option on my put side having delta greater than 0.15. Thus I kept my put side winning chance at 85%.

Warning: For the benefit of readers, I am telling a rule in advance which is not used yet. Never sell more than half of the available lots on one side. So if I have 6 lots, I would not sell more than 3 lots on any side. This is because if the market reverses violently, I would not be able to manage 4 lots on the losing side by using just 2 lots on the winning side. In the above example, If Nifty keeps rallying, I will not sell any more put options. Instead I will just keep rolling the put side until it is time to exit the call side in loss. I will cover more details when the situation arises.

Market close summary

Realized P&L for the day : +1713.75

Realized P&L for Feb : +1713.75

MTM : -1260


Day 1 : 4 Feb

Trade 1 

The Chinese stock market had started recovering. Nifty opened on a positive note and at 10:00AM it was trading at ~11840. IV percentile had dropped to ~48. Time had come to enter a Strangle and trap Nifty in a range, and earn the theta decay. Only if things would have been so easy! Anyway, I decided to take the following Strangle position:

Sell 1 lot 11350PE

Sell 1 lot 12200CE

Why these strike prices ?

Now the question comes, why did I choose these strike prices ? Simple! I want to be in a trade with ~70% probability of winning. Delta of an option tells the chances that option will end up ITM by expiry. So if i sell an option with 0.15 delta, there is 15% chance it will be ITM and I will lose. So If I chose to sell both CE and PE at 0.15 delta there is a 15% chance of losing on the call side and 15% chance of losing on the put side. Hence a 70% chance of winning (100 – 15 – 15). I went to the option chain provided by Sensibull and checked the deltas. 11350PE and 12200CE had a delta of 0.15. So I decided to sell those options. Traders can choose to sell higher delta options based on their risk appetite. Keep in mind, that no matter what strike price you choose, both should be at same delta. This makes your strangle delta neutral. 

Why make the position delta neutral ?

Again, no need to go too mathematical. A delta neutral position does not make profit or lose as Nifty moves in any direction. The profit comes from time decay. But the catch is we need to keep adjusting our position to keep it delta neutral. As Nifty moves, position loses its delta neutrality and becomes directional.

Risk management ?

This topic is extremely important. We will be carrying our short position overnight. I do not know what may happen tomorrow in world markets. So I need to put some measures to hedge overnight risks. So I took the following position:

Buy 1 lot of 10800PE

Buy 1 lot of 12700CE

There is no delta logic in choosing the strike prices. I usually chose strike price ~500 away from my short option strike price. For each lot sold, I buy 1 lot. You might be wondering if my risk is ~500 points which is too high. You are right. To be losing 500 points, the market would have to move ~1000 points overnight and not reverse till expiry. This would be a once in a few years event. I just want to sleep with peace that even if the worst happens, I do not lose more than my capital. Even in the worst case, I would be losing 25-30% of my capital. Based on your risk appetite, You can choose a farther or nearer width. But no matter what, do not carry naked short position overnight. 

Note: We would not consider deltas of long options while maintaining delta neutrality of the strangle. These options are buy and forget. It is insurance for emergency.

Why sold just 2 lots with a capital of 6 lots ?

If I would have sold all 6 lots at the same time, I would not be left with any lots to make adjustments. I would just have to hope that Nifty remains within my strangle range. Remember, hope is never a good strategy. My rule of thumb is, divide your total available lots into 3 equal parts. Use 1 part to form the strangle. Keep the remaining 2 parts for adjustments later. So 6/3 = 2. I will use 2 lots to set up the strangle and keep 4 lots for adjustments. Do not worry that you are wasting your capital, Nifty does move in a month’s time and all these lots will be used at some point of time. 

Trade 2

Nifty kept rallying for the entire day. At ~1:40 PM, Nifty was trading at ~11965. A 125 points move from when I entered the Strangle. This is a super big move for Nifty. Usually it takes days to give such a big move. But this happened within a span of a few hours. My call side was in trouble. It was time for some adjustment in my strangle. I placed the following order:

Sell 1 lot of 11500PE

Buy 1 lot of 11000PE for risk management

When should I adjust my position ? 

I do the following to decide when to do an adjustment.

I calculate the net delta of my position. Take its absolute value. Then I divide this  value with the number of options I have sold currently. If it comes out to be greater than or equal to 0.075, it is time to adjust. No need to go too mathematical. I follow this formula, because I can very easily delta neutralise this position by selling an option of 0.15 delta on the winning side. Let us understand this with above example:

When Nifty rallied to ~11965, my position had the following delta:

11350PE : 0.10 x 1

12200CE: -0.26 x 1

Net delta = 0.10×1 – 0.26×1 = -0.16 (Ignore the sign, only take absolute value which is 0.16)

Total lots sold = 2

Average delta of position = 0.16/2 = 0.08

Since 0.08 >= 0.075, It is time to adjust.

Now the option chain showed that 11500PE was at delta of 0.15. Since currently Put side is the winning side, I will sell this 11500PE. See how simply I have delta neutralised my position once again. New position:

11350PE : 0.10 x 1

11500PE: 0.15 x 1

12200CE: -0.26 x 1

Net delta = 0.10×1 + 0.15×1 – 0.26 = -0.01 (almost zero)

I will repeat the formula here as It is the only and most important formula to remember for adjustments. It is time to do an adjustment when:

(Absolute value of position delta / number of lots currently sold) >= 0.075

How to adjust my position in the above example ?

Once I have decided that adjustment is needed based on the above formula, I make an adjustment. If I have margin available to sell more lots, I adjust my position by selling 0.15 delta option on the winning side. If I do not have any more lots for adjustment, there is a different rule. We will cover that later once such a situation arrives. In the above example, I sold 11500PE as put was the winning side and 11500PE was at 015 delta. After this adjustment, my position is again delta neutral. Any small movement in Nifty can not hurt my position any more, and I will keep enjoying the benefits of time decay.

Why not just roll 11350PE ?

Many traders will ask that I could have easily delta neutralised the position by rolling the put side. Why all this formula! We could have exited the 11350PE in profit and sold another PE closer to the current ATM strike price. This will instantly lock the profit of 11350PE and make the position delta neutral at the same time. This works, but it has one major problem. If the market reverses, my put side will be in too much trouble too soon. I will explain this using the above example. 

When Nifty rallied to 11965, 12200CE was at 0.26 delta. To delta neutralise by rolling the put side, i will have to sell a put option at 0.26 delta. The 0.26 delta option was 11700PE. If the market reverses, 11700PE will be in trouble much sooner than 11500PE. Also, my probability of winning has greatly reduced by selling 11700PE. Noe my strangle has both sides with delta of 0.26. This means my winning chance is 48% now (100 – 26 – 26). Remember the delta tells the chance an option will go ITM by expiry. By selling 11500PE, I have ensured that my Put side still has the 85% chance of winning. For the call side, I will keep adjusting until the market reverses or I am unable to adjust anymore.

Market close summary

It was a tough day for strangle. Nifty kept rallying for 270 points. But the losses are not yet final, Market can reverse anytime and we still have ammunition for more adjustments. The game is on! There are many more scenarios yet to come, and I have pre-defined rules for each of them. I will explain each of them through real trades when time comes.

Realized P&L for the day : 0

Realized P&L for Feb : 0

MTM : -532.5

P&L for 4 Feb
P&L for 4 Feb

=================================

Disclaimer: Options involve substantial risk and are not suitable for all investors. Options investors may lose the entire amount of their investment in a relatively short period of time. It is possible to owe more than you have invested in your brokerage account. Please be aware of your broker’s requirements for trading options. Before you decide to invest in the options market you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a substantial loss which could total more than your initial investment in a short period of time. Therefore you should not invest money that you cannot afford to lose. If you have any questions or concerns regarding the risks associated with option trading, you should confer with a trusted and reliable independent financial advisor. None of the information provided in this blog constitutes a solicitation to trade any investment or security of any kind.

13 thoughts on “Strangle Adjustment : Nifty Feb 2020 series”

  1. Did not understand one thing:
    Day 1
    You added 11500 with out exit 11350
    Day 2
    You added 11650 -2 lots and exit 11350
    The logic behind this is not understand.
    Your explanation is very good bro. It is so helpful.

    1. Thanks for asking, a very valid question.
      In every adjustment, my goal is to make delta of both call side and put side to be equal or as equal as possible. This is called delta neutrality.
      If I have more lots to sell, I will achieve delta neutrality using combination of 2 ways:
      > Selling more options with ~0.15 delta on the winning side
      > Exiting options on the winning side in profit.

      Note:
      I will exit options on the losing side if above 2 does not help me get to delta neutrality. As exiting on losing side locks down the loss.
      > There is no point selling more option on the losing side as this side is already in trouble. It will not delta neutralise the position.

      On Day 1:
      Call side was at 0.26 delta and put side was at 0.1 delta
      By selling 11500PE at 0.15 delta, put side got to 0.25 delta (0.1 + 0.15) which is very close to 0.26 delta of call side. Hence nothing more to be done.

      On Day 2:
      Call side was at 0.29 delta. Put side was at 0.15 delta (0.06 of 11350PE & 0.09 of 11500PE)
      Now i sold 2 11650PE which had 0.15 delta. So new delta on put side becomes : 0.45 (0.06 + 0.09 + 2*0.15)
      To make put side delta equal to call side delta, I just exited 0.06 delta 11305PE. New put side delta becomes: 0.45 – 0.06 = 0.39
      Now both call an put side are at 0.39 delta.

      Once we have decided that adjustment is needed, we need to do these plus minus to make our position as delta neutral as possible.

  2. This is a very well explained strangle position and its adjustment and I believe the nature of fluctuation in current month will be very informative for new option traders.

    I would love to know your thought process on profit target setting and profit booking. Stop losses have already been covered. Thanks in advance.

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