The Simplified Futures and Options Trading Strategy
By Avinash Khilnani
Copyright @ 2013 Avinash Khilnani
1. INTR ODUCTION: ODUCTION: OF MICE AND MEN 2. DERIVATIVE DERIVATIVE PRODUCTS PRODUCTS Futures Options Call options options Call option as option as a bet Put Options Options Put Option as a bet
3. OPTION OPTION PRICING WORKSHEET WORKSHEET The Black-Scholes Black-Scholes Model
4. THE SIMPLIFIED SIMPLIFIED TRADING TRADING STRATEGY The Contrary Contrary Positions Rule (CPR) The advent advent of a bullish scenario The advent of a bearish scenario The Exit R ule ule The Three Acts Acts Play Summarized Summarized
5. WALK THE THE TALK TALK The Month Month of A pril-2012 The Month Month of May-2012 The Month of June-2012 The Month Month of July-2012 The Month Month of August-2012 The Month of September -2012 The First Half Results The Month of October – 2012 The Month of November – 2012 The Month of December – 2012 The Month of January – 2013 The Month of February – 2013 The Month of March – 2013 The Second Half Results
6. IN CONCLUSION: OUTSMARTING MICE
There is a very easy way to return from a casino with a small fortune: go there with a large one. - Jack Yelton.
1. Introduction: of Mice and Men Is the human mind programmed to look for patterns, even when there are none, or to miss seeing patterns even when these are obvious? If the financial market is like a casino, ruled by chance, there would not be any patterns to look for. If however, the whims of market players do influence the price movements of stocks, commodities, currencies or market indices, there is perhaps a chance that a trader may look for profitable patterns in apparently random movements. But then, the human mind also seems incapable of understanding chance. The notion of a gambler’s fallacy illustrates this candidly. If one flips a coin a billion times, the chance of getting a head is half a billion times while the chance of getting a tail is also half a billion times. Thinking along these lines, one might believe that after getting seven tails in a row, the chance of getting a head is higher on the eighth flip. Well, it’s not. The chance of getting a head on the next flip is still a half, even if the tails appeared for a million times! This fallacy arises because the human mind tends to replace the law of chance with the so-called law of averages, which is actually a fallacious inference from the theory of probability, usually called Bernoulli’s theorem. The French mathematician, Simeon Poisson, made the theorem popular by renaming it as the Law of Large Numbers. Yet this muddleheaded idea, misnamed the law of averages, as a misinterpretation of the probability theorem, underlies all gambling systems. There can not be a system to improve one’s chances of winning in a game of chance. That’s exactly why it is called a game of chance and is also the reason that the casino always makes money while the gambler loses money consistently in trying to outsmart chance.
Not too long ago, behavioral scientists’ experiments with mice yielded interesting results. The experiment involved flashing green and red lights at random, but the green light flashed 75 percent of the time. The mice were rewarded with food if they guessed correctly what light will flash next. In a matter of time, the mice could infer that the green light would flash more than the red light, and so seeing a pattern in randomness, they simply guessed green every time. The mice were rewarded 75 percent of the time and were quite happy with their results. Not so with humans. We, being the ‘smarter’ species, would impose our patterns on the randomness and guess that since the green has flashed a number of times, the next light to go on should be red. Humans guessed right only 60 percent of the time. The gambler’s fallacy worked to our disadvantage, and actually demonstrated that mice are far better decision makers than us humans. The human mind has a peculiar characteristic of fooling us into thinking that e can control chance, and insists on imposing patterns on reality that are not there, or worse still missing patterns that are there. As if that’s not enough, most of us have this optimism bias that instills ishful thinking into our behaviors, leading us on to make bad economic decisions. The same bias also makes us loss-averse and stops us from getting out of obviously risky ventures. On top of that, our financial market with all its complexity, having evolved as an information system with its own intelligence, has worked to force us to impose order into chaos and to lead us further away from looking for patterns. In an effort to not miss any such patterns, market players have been trying various chart analysis tools to identify them. Patterns are easily discernible on a chart and a cursory glance at the modified Heikin Ashi chart will immediately reveal the ongoing trend in a market index, stock, currency or commodity price movement. Coupled with the golden ratio of a Fibonacci sequence, trend patterns and changes in trends are readily observable. I have outlined the construction of the chart and triggers based on the Fibonacci ratio in an earlier book titled “The Modified Heikin
Ashi Fibonacci Trading System” and the current book on trading strategy is a natural extension of that trading style. Trading the modified Heikin Ashi charts, we could see that although half of the trades turned out to be winners and other half losers, the profits on the winners were almost twice as large as the losses on the losers . Thus, we did manage to play the game the way mice did in the green-red-light experiment by acting consistently over time and winning 75 percent of the time, since our inning actions yielded more money than the losing actions gave away. In trying not to outsmart observable patterns, we behaved as rationally as the mice did and stayed in the game. After all, we do have the same number of active genes in our genome as the mice do, about 30,000 in all. So men and mice are much alike in that sense. But how about outsmarting mice? Since we are also quite vain about us being the smartest of all species on earth, we have designed highly complex financial markets and its complicated financial tools. For a long time now, we have been using these financial instruments as hedging tools to offset losses when trading patterns change. And they do change, rather frequently and randomly. This book is about demonstrating the use of derivatives tools known as Futures and Options effectively in two ways: 1. initially, about getting on the right side of market by identifying and trading the observable trend pattern in price movements, and 2. Subsequently, to realize that patterns can change randomly so an appropriate strategy is to be inculcated into the trading style to not just offset any loss by an imminent change in pattern but to actually increase profit potential from such a change, should it occur. I may stress here that the trading style demonstrates results empirically in that hat has happened in the past does not in any way guarantee what will happen in the future. You should use the suggested strategy as per your own discretion and are solely responsible for your actions resulting in profits or
losses. You are buying this book on the understanding that neither the author nor publisher is engaged in any professional service or advice by publishing this book. You should seek the services of a competent finance professional to ensure that a situation is evaluated appropriately. The author and publisher disclaim any liability, loss or risk resulting directly or indirectly from the application of any content in this book. With that evil but necessary disclaimer in place, let’s move on to what trading in Futures and Option is all about. Now, in order to to employ these these tools as a necessary part part of your trading trading actions, you must be familiar with trading futures and options. So, the next chapter is on the basics of Futures and Options trading to introduce these derivative products. If you are already well versed in their use and understand the concepts of option pricing, price decay with time and implied volatility, you may skip the following chapter. However, the subsequent section on option pricing may come in handy for you in that you may create a simple enough worksheet to calculate option prices, implied volatility and the Delta. You are then then led on to a simplified trading strategy that is devised to overcome the inherent human mind characteristics of imposing patterns when there are none and also to make redundant the dreaded optimism bias so typical of human traits. The strategy predicts a maximum profit potential at the beginning of each action and also gives reversal points in trading patterns with simple mathematical formulae which you can easily embed as a worksheet in the already existing spreadsheet that you created from the last book in this sequel. To ingrain the strategy successfully in your trading psyche, you might need to ork through a couple of months on index futures like the Dow Jones Industrial Average Futures. The most popularly traded Dow Jones futures are: 1. the E-mini E-mini Dow Futures that have a multiplier multiplier of $5 $5 (ticker (ticker symbol symbol
YM on the CME Globex), and 2. the DJIA Dow Futures Futures that have a multiplier of $10. $10. (ticker (ticker symbol symbol ZD) There are also the Big Dow futures with a multiplier of $25, and ticker symbol DD. The book then suggests a clear and well defined strategy of playing the futures against options. So you should be familiar with index options as well. If you are playing the Dow futures, you need to understand the corresponding Dow options. For the Dow Jones index, we have the DJX options that are of a European style and so can be effectively set against the E-mini ($5) Dow or the DJIA ($10) Dow futures. The S&P 500 options have their counterpart European style options as SPX, if you want to play the SPX futures that are based on this index. You need to make sure that the options you sell with this strategy are European styled, since American type options have this bothersome aspect of being exercised against against you if these these options happen happen to become in-the-money. in-the-money. The book then walks you through twelve months of trading the S&P CNX Nifty so that you you can trade any other index, stock, stock, currency or commodity that has actively traded futures and options on any other exchange. I have taken a ‘real world’ trading example in Nifty since the option contracts in this index are European styled with monthly expirations, and the historical data of both futures and and options is freely and publicly publicly available, so that you can verify the option prices. The DJX or SPX historical data may not be freely accessible except perhaps through your brokerage trading platform. I continue that walk for the ongoing present month, demonstrating demonstrating the strategy of playing the E-mini Dow futures against the DJX options (European styled) through the web pages at niftytracker.com niftytracker.com.. As you patiently walk along with me through trading the futures and options combinations, combinations, you would soon affirm a trading style in your psyche as an
optimum technique to play index futures against index options. That trading psyche is an attempt to outsmart mice, and so the concluding chapter is a debate on who turns out to be smarter: men or mice.
If you want to make God laugh, tell him your plans. – Woody Allen
2. Derivative Products Derivative products are called so because they are derived from the underlying index or stock or commodity or currency prices. The most actively traded derivatives are Futures and Options.
Futures Let's start from the basics, assuming you are new to derivatives trading. You might skip this section if you are familiar with and are already trading futures and options. Consider the Dow futures as a derivative product of the index known as the Dow Jones Industrial Average or US 30 that is dependent on the actual value of spot DJIA. You cannot trade the spot or the actual DJIA, which is a weighted aggregate of thirty very liquid stocks, but you can trade its futures. The price of the Dow futures may be higher (at a premium) or lower (at a discount) than the spot (actual) value of US 30, depending on the perception of traders. For example, if E-mini Dow futures are being traded higher by about 50-100 points than the spot Dow, the market players expect the Dow to close higher than the current value by expiry day, the final settlement date. Now, unlike stocks, which you must have in your trading account in order to place a SELL order, futures can either be sold or bought, according to your view of the market. So, if you believe a market index like the DJIA (or share price of a particular stock, like Google) will fall, you can execute a SELL order in its Futures (even if you do not have Google shares in your account). If the actual value of index or stock price does fall, you will make a profit by buying back the Futures you had sold, which will be the difference between the price at which you had sold the futures and the price at which you have now bought back the sold position in your derivatives portfolio. When you buy back the Futures, your derivatives position will be squared off and the sell position will no longer show in your portfolio. Likewise, if you think the stock price (or an index like the US 30 or S&P 500), is about to rise, you will execute BUY to create an open position of long futures of that stock or index, in your trading account. To square off, simply sell the Futures, and if the value of the underlying stock or index has
indeed risen, you have made good money. You can square off your derivatives positions any time you want to, within a second of creating the position or the next hour, or on any other day till the expiry day of the Futures' delivery month. Leveraged Trading
Futures trading has this advantage that you only need to have some margin money in your account to be able to execute high volume trades because of the leverage available in such trades. Margin is the amount of cash a trader must have as collateral to support a futures or options contract. Margin requirement are based on risk analysis algorithms and can vary from time to time, and from exchange to exchange worldwide. Index futures have a multiplier that inflates the value of the contract and so this is called leveraged trading. For the DJIA, this multiplier is 10. The EMini Dow futures have a multiplier of 5. The S&P has a multiplier of 250 and for the NASDAQ it is 100. This is leveraged trading, i.e. with a little cash; you are leveraging your trades to much higher volumes. Of course, both your profits and losses are magnified to that extent. So, for example, if the Dow futures are trading at 14,000 and if you bought one futures contract, it would be worth $140,000. If the Dow went up by just one point, this would mean a $10 profit in real terms for you, and in mark-to-market terms, would be settled daily until you close out the position by selling the contract or the exchange does that for you on the expiry date. If the index fell by 100 points, this would imply a loss of $1,000 since you were long on the Dow. Derivatives Expire
Futures as derivatives products of a certain delivery month are set to expire on a scheduled date during that month, and are denoted as such. The Dow, S&P, NASDAQ and other index based futures have quarterly cycle delivery months like Mar, June, September and December.
The Dow-Jun13 contracts would expire on June 20, 2013 while the NasdaqJun13 would expire on June 19, 2013. The expiration date is usually the third Friday of delivery month. The FTSE 100 futures contracts would also expire on the third Friday of delivery month, but the Nifty futures on the NSE, India usually expire on the last trading Thursday of that month, unless the day happens to be a trading holiday, in which case an earlier or later day may be selected by the exchange. The Nifty futures, in contrast to the Dow and other indices, have monthly delivery months. So, if you have open position in futures which you have not squared off, the exchange will compulsorily close out (square off) the position at the closing of the expiry day. The loss or profit will be adjusted to your account according to the closing price of the expiry day. Futures are thus derivatives contracts between the seller and buyer and are actively traded as contracts named after the delivery month. These are then known as, for example, YMZ13 (Dec 13 contracts for the E-Mini Dow), or DOW-Jun13, or SP-Sep13 etc. You can initiate trades on any of these, though Mar-14 futures may not be as liquid (or as actively traded) as June-13 or Sep13 futures. With this background on Futures contracts, let’s move on to the other derivative instruments called the Options, which are a pretty handy tool for hedging risks involved in trading futures or stocks.
Options Another class of derivative products is the options. These can be 'call' or 'put' options.
Call options A call option is the right to buy a certain property at an agreed price before a certain date, by paying a premium. The premium is like a signing amount or advance you would give to the property seller, promising to come back before the agreed date (which is the expiry date) with rest of the asset's value to acquire the asset. Setting aside the basic definition, note that in the F & O market, since European styled options (like the DJX and SPX) are cash settled, you don't have to actually acquire the asset. If the value of the asset (in our case the index Dow or S&P 500 or Nifty, or share price of a stock) went up and you had bought a call option on it, you would be paid the profits made on the option at expiry, or if you decide to square off (sell) the option on any other day prior to the expiry date, you would rake in the profit on that day. You don't have to wait till the contract’s expiry. Options too have a multiplier that inflates the value of an option contract, and so an option trading is also leveraged to the extent of the multiplier. The Dow index options have a multiplier of 100. So, if you are buying the DJX call options for a price of say, $2.95, the premium that you need to pay to hold the option is $295.00. The S&P 500 and NASDAQ 100 options also have a multiplier of 100. The S&P CNX Nifty options have a multiplier of 50. It’s very important to look at the multiplier because that is what decides the size of the contract, also called the lot size. It is also important to check if the options are American or European styled. Always prefer playing the European style options because these can not be exercised against you if the underlying index goes above the strike value of
the call option, or in the case of a put option, if the underlying index falls below the put option strike. It is worth noting here that the E-Mini Dow options (YM) are American style, as are all the ETF based options. So, if you are playing the E-Mini Dow, remember to offset these against an equal number of Dow units by selling the DJX options which are European styled. A general notation for the DJX option can be as below: DJX Nov 2013 153.000 call, or DJX131116C00153000. This is a call option for DJX that is based on the underlying index of Dow Jones, and is set to expire in the month of November 2013, after 16 th of November. The call option is for the strike of 153, being 1/100 of the Dow Jones index of 15,300. A corresponding put option would have a notation like: DJX Nov 2013 153.000 put, or DJX131116P00153000. But more on the put options later in that section.
Call option as a bet A call option, then, is a contract or a bet taken on the stock price or index value. There is a seller (also called the ‘writer’ of the option) and a buyer (also called the ‘holder of the option). Take an actual example of the S&P CNX Nifty call options of strike 5400. Let's make a bet on the Nifty that the index would reach beyond 5400 by the expiry date of 26-April-2012. In this case, 5400 is our 'Strike' price; the option is this month's call option is labeled as 'Nifty -April-5400-CE’. The table below lists the actual call option prices, with the last column
showing the value of the underlying which in this case is the Nifty 50. This historical data has been sourced from the publicly accessible nseindia.com archives.
Date 30-Mar12 2-Apr12 3-Apr12 4-Apr12 9-Apr12 10-Apr12 11-Apr12 12-Apr12 13-Apr12 16-Apr12 17-Apr12 18-Apr12 19-Apr12 20-Apr12 23-Apr12 24-Apr12 25-Apr12 26-Apr12
NIFTYCE
APR-26-2012
Open
High
Low
LTP
Settle Price
Strike: 5400 Underlying Value
64.4
91.5
59.1
82.75
87.95
5295.55
80
90.7
73
82.4
80.5
5317.9
90
98.55
83
88.65
89.1
5358.5
79
79
63.5
72.2
70.8
5322.9
44.65
53.1
34.95
36.5
36.8
5234.4
38
40.1
29.8
36
36.95
5243.6
27
40.65
22.9
35.5
31.7
5226.85
36.1
44.5
33.35
36
38.65
5276.85
44
46.5
15.25
18.8
21.5
5207.45
15.05
24.8
14
23.5
22.9
5226.2
18
35
16.15
29.85
30.3
5289.7
35.5
40.1
21.7
22.45
25.65
5300
28.9
33.8
21.05
33
30.15
5332.4
25.5
26
6.8
12
12.75
5290.85
10
11.75
1.8
1.9
2.35
5200.6
1.9
2.5
1
1.25
1.3
5222.65
1
1
0.25
0.3
0.3
5202
0.1
0.15
0.05
0.05
0
5189
Table 1 (Source: nseindia.com)
I may decide to sell (or, write) the option, believing that Nifty would not go beyond 5400 by the close of expiry date. And if you decide to buy the option, hoping that the index would reach much higher than 5400, our agreed strike price, you are going long on the option. We agree on a bet price of, say 86, near the closing price on 30-Mar-12. The value of the underlying NIFTY on this date is around 5295. You, as the buyer would pay me this amount (the premium), and I would get the cash in my account the same day. If Nifty does indeed reach beyond 5400 to, say, 5500, I would have to pay you the difference in strike price (5400) and the actual value of Nifty (5500, in our hypothetical scenario) which is 100 units in cash. So you would have made a profit of 14 units (you had paid 86 units earlier), and I would have taken a loss of 14 units, I lost the bet on the strike price of 5400. You would lose the bet, on the other hand, if Nifty could not reach beyond 5400, with your position of BUY in this option returning nothing. You would lose the entire premium you paid me. In this scenario, you can see that you ould not actually make any money unless Nifty crosses 5486, which would serve as the breakeven point for your position. Only if the underlying crosses this breakeven point, would you make any profit from your bet. A value of 5401 at the expiry date would yield you just a unit, and that would mean a loss of 85 for you, and a profit of 86 for me. As the buyer (or holder) of the call option, your maximum loss can only be the amount you paid me as the seller (or writer) of the option, while your maximum profit potential is unlimited since the index may rise to unprecedented levels. For the writer of the option, the maximum profit is just the amount received at the time of selling the option, but the maximum loss potential is unlimited as the index can rise indefinitely.
This strike example was an out-of-the-money (OTM) strike price, since on the day we entered into a contract; the underlying asset was at 5295 while the strike price selected was 5400. There are various strikes available on Nifty, so 5300 would be called 'at-the-money' (or ATM) option and 5200 as the 'in-themoney' (or ITM) option; the underlying is already above 5200. As you ponder over the table above, notice that the value of the option price seems to depend on the underlying asset. As the Nifty falls, so does the price of the option. However, during the initial couple of days when the Nifty does rise a bit to a level of 5358 and 5322 on the 3 rd and 4th of April, the option price does not seem to rise in tandem. And in fact, when the underlying is at 5332 again on the 19 th April, the option price has actually taken a beating at being quoted around an average price of ust 31 units, although the underlying value is higher than the day on which you bought the call options. Apparently, there is more to option pricing than just the underlying. The option price, being a contract value between the seller and the buyer, is also dependent on the number of days left to expiry since it has an expiry date and also an initial perception of the market view held by the market players built in, which is reflected as ‘implied volatility’. So, initially, the option price was rather high on 30 th Mar, since the days left to expiry were more, and the expectations of the market players of the Nifty being bullish led to their willingness to pay higher price for the call option. This factor alone resulted in higher implied volatility for the option. Thus, the option price depends largely on: 1. the underlying value, 2. the number of days left to expiry, and 3. the implied volatility (IV). With time, IV is generally expected to decline as the number of days to expiry decrease, and even with the underlying gradually rising, the option price may not rise in step because now the market players may not be willing
to pay too high a premium on the option. So, for a corresponding rise in the underlying, the rise in the option price may not be as much as it was initially. This sensitivity of the option price to the underlying is measured as the ‘delta’, denoted as the Greek letter ∆. This is the most important Greek in option price calculation and along with IV is going to play a critical role in your exit plan strategy. In trading derivatives, you need to appreciate that writing options is the best option for you, since you have two very important friends on your side: Implied Volatility and TIME. Both these allies on your side will work to reduce the option price as the expiry date approaches, resulting in an effortless profit for you if the market does not move, or moves very little. Another ally for you is the trend with whom you are already familiar, and you are soon going to have these folks on your side with the simplest trading strategy explained in this book. But before that you need to understand the complementary to call options:
Put Options These are the other options in the derivatives segment. The exact opposite of a call option, the put option holder has the right to sell a certain property at an agreed price before a certain date, by paying a premium. Setting aside the basic definition because in the F & O market and noting again those as options are cash settled for European styled options, you don't have to actually hand over the asset. If the value of the asset (in our case the index Nifty, or share price of a stock) went down by the expiry date and you had bought a put option on it, you would be paid the profits made on the option at expiry, or if you decide to square off (sell) the option on any day before the expiry date, you would rake in the profits on that day. You don't have to wait till expiry. A put option, then, is a contract or a bet taken on the stock price or index
value between the seller (the writer of the option) and a buyer. The contract size, or the lot size, of a put options is also dependent on the multiplier. Put options would have the same multiplier as the call options for that same particular index or stock.
Put Option as a bet Take an example of the Nifty. Let's make a bet on Nifty that it would fall below 5100 by the expiry date of 26-April-2012. In this case, 5100 is our 'Strike' price, the option is this month's put option labeled as 'Nifty-April5100-PE’. I decide to sell (or, write) the option, believing that Nifty would not fall below 5100 by the close of expiry date. And you decide to buy the option, hoping that the index would drop much below 5100, our agreed strike price. We agree on a bet price of, say 49 units on 30-Mar-2012. You, as the buyer ould pay me this amount (the premium), and I get the cash in my account the same day. NIFTYPE Date 30-Mar12 2-Apr12 3-Apr12 4-Apr12 9-Apr12 10-Apr12 11-Apr12 12-Apr12 13-Apr12
Open
High
Low
LTP
APR-26-2012 Settlement Price
Strike: 5100 Underlying Value
81.5
81.65
45
50.45
48.15
5295.55
52.1
52.85
31.15
32
34
5317.9
29.4
29.4
21.4
23.8
24.1
5358.5
29.4
31.75
27.1
27.5
29.65
5322.9
35
46.4
32.6
44.95
43.85
5234.4
40
50.35
34.85
37
37.5
5243.6
44
53.5
29.3
38.3
42.25
5226.85
38.9
38.9
26.3
28.95
28.25
5276.85
30
51.2
18.5
45.2
43.75
5207.45
16-Apr12 17-Apr12 18-Apr12 19-Apr12 20-Apr12 23-Apr12 24-Apr12 25-Apr12 26-Apr12
51.9
51.9
28.05
28.95
31.65
5226.2
36.9
37.7
10.7
11.25
12.1
5289.7
10.8
10.8
7
8.6
8.5
5300
7.3
7.75
3.55
3.6
4
5332.4
4.15
16
3.1
5.6
6.45
5290.85
6
17
2.65
17
14.65
5200.6
7.8
15
4.95
5.3
6.1
5222.65
3.85
16.9
2.9
3.55
3.8
5202
1.1
1.1
0.05
0.05
0
5189
Table 2 (Source: nseindia.com) If Nifty does indeed crash below 5100 to, say, 5000, I would have to pay you the difference in strike (5100) and the actual value of Nifty (5000) which is 100 units in cash. So you made a profit of 51 (you had paid 49 earlier), and I took a loss of 51. On the other hand, if Nifty did not fall to below 5100, your position of BUY in this option returns nothing, and you lose the premium you paid me. So you ould not actually make money unless Nifty dips below 5051, which serves as your breakeven point. A value of 5099 at the expiry date would yield you just one unit to you, and that would mean a loss of 48 for you, and a profit of 48 for me. This strike example was an out-of-the-money strike price for put options. There are various strikes available on Nifty, so 5100 would be called 'at-themoney' option and 5400 as the ‘in-the-money' put option because the index as already below this strike price on 30th March 2012. As the buyer (or holder) of the put option, your maximum loss can only be the amount you paid me, the seller (or writer) of the option, while your
maximum profit potential is unlimited since the index may fall to pre-historic levels. For the writer of the option, the maximum profit is just the amount received at the time of selling the put option, but the maximum loss potential is unlimited as the index can fall back to its base level or even below that. Contemplating on the table above, you can see that as the Nifty value underlying the put option begun rising initially, the put option price declined along with every rise in the index. This shows that put options have a negative Delta in contrast to call options which have positive Delta. However, as the index fell back the price of the put option begun rising until the 13th April, when it was quoting at 43 for the underlying at 5207. So, although the Nifty has indeed dropped some 90 points since you bought the options, the option price is somewhat below what you paid me on 30 th March. The time factor has obviously worked against your BUY position in the put option. The Greek Delta too has not been kind to the option price. As the index rises and falls back to 5200 on the 23 rd April with only 3 days left to expiry, the option price has dropped even further. The expiry day sees the Nifty close at 5189, which is still above the strike price, resulting in the exchange closing out your position returning nothing. The Put option has expired worthless for you as the holder of option, while I get to keep all the money I received as the writer of the option. The pricing of the put option, as with the call option, also depends on underlying value of the index or stock, the number of days left to the expiry date and the perception of the market players reflected as implied volatility. Option pricing also depends slightly on a number of other factors like dividend yield and the general interest rate. The next chapter explains a popular option pricing model which you can use to estimate option prices and to calculate implied volatility along with Delta.
After a certain point, money is meaningless. It ceases to be the goal. The game is what counts . – Aristotle
3. Option Pricing Worksheet Now that most of the options traded are the European type, you may apply the Black-Scholes model to calculate option price, implied volatility and Delta. The European type option cannot be exercised against you if you are the riter of the option, which simply means that the holder of the option cannot force you to pay up in case the option is making you a loss. You can, of course, square off the option at will, and so can the holder at any time on or before the expiry of the contract. In the American type of options, the holder of the option also has the right to exercise and if such a request comes in from the holder, the exchange can then randomly force any writer to close out the position at a loss. The model below that is used to calculate option prices works for the European style of options and since you will be writing just these types of options, this should work very conveniently for your purposes.
The Black-Scholes Model These two gentlemen came up with a rather complex formula to estimate IV given the option price. Without going into the detailed mathematical explanations, which would be rather cumbersome and quite un-necessary for our purposes here, let’s get down to actually creating a worksheet for the model. The inputs or parameters involved in their formula are: 1. 2. 3. 4.
the Spot price of the underlying, which is the stock price or index. the Strike price of the option. the number of days left to expiry; this is to be converted into year units. the Implied Volatility, which can be estimated by the model given a value of the option price. 5. the risk-free interest rate, specific to your country or region, and 6. the dividend rate, which could be an aggregate guess for the stocks in an index, or a specific stock’s dividend rate if you are estimating that stock’s option prices.
In your working spreadsheet for the modified Heikin Ashi Fibonacci triggers, you may insert a worksheet and name this new worksheet as ‘Option Pricing’. Now, in column A and B, and through rows 1 to 6, type in the column headings and row parameters as shown below:
1 2 3 4 5 6 7
A Parameters Spot Price Strike Price Expiry in Days Implied Volatility Risk free Interest Dividend Rate
B Value 5295.55 5100 27 0.19200
0.09 0.21
In this example, the column B contains the values of the parameters as the input data. I have shown the values for the 5100-PE from Table-2 for 30 th March 2012. Next, you need to calculate the four factors as given by the Black Scholes model in the next four rows, denoted as d1, d2, nd1 and nd2. But before these four factors, please convert the time to expiry from days to years by dividing the number of days with 365, in cell B9. Leaving row 8 blank as a separator between the inputs and calculations, you have the next five rows too and your worksheet now looks as follows:
1 2 3 4 5 6 7 8 9
A Parameters Spot Price Strike Price Expiry in Days Implied Volatility Risk free Interest Dividend Rate
Expiry in Years
10
d1
11
d2
12
nd1
13
nd2
B Value 5295.55 5100 27 0.19200 0.09 0.21 *(type in formula) *(type in formula) *(type in formula) *(type in formula) *(type in formula)
Since cells B9 to B13 contain formulae, you might color these cells differently, and protect the cells so that you do not inadvertently overwrite the formulae. Type in the formula “=B4/365” in cell B9, to convert the number of days into the year format.
The cell B10 contains the formula for d1, which is calculated by putting in the formula: “=IF (ISBLANK(B7), LN(B2/B3)+((B6+(0.5*(B5^2)))*B9), LN(B2/B3)+ ((B6-B7 + (0.5*(B5^2)))*B9)) / (B5*B9^0.5)” This may seem intimidating, (notice the Excel notations for exponentials, natural logarithms, and square roots – enough of mathematics to spoil your breakfast) but if you typed in all the right letters and symbols, and you are getting the value 0.57666 in cell B10 with the inputs exactly as seen in the orksheet so far, you know you have got it right. Cell B11 for calculating d2 is easy enough to type in. The formula is “=B10B5*B9^0.5”. Next in queue are the standard normal distributions nd1 and nd2. The MSExcel already contains the function for standard normal distribution calculation to do that, so all you need is to type in the two cells B12 and B13 the formulae : “=NORMSDIST(B10)” and “=NORMSDIST(B11)” respectively. (I will not venture into explaining what standard normal distribution functions or exponentials and natural or base 10 logarithms mean here, or hy they are here at all. That would make a separate booklet in itself. Suffice it to say that the model works as a pretty good approximation of option prices and implied volatility). If you have done everything right so far, the formulae in cells B9 to B13 ould be returning the following figures: A Expiry in Years d1 d2 nd1 nd2
B 0.07397 0.57666 0.52444 0.71791 0.70001
If this seems right for you, you may proceed to calculate the option prices in columns D and E, leaving column C as a separator. Type in the parameter for column D as shown in the table representing your orksheet here:
1
A Parameters
2
Spot Price
3 4
Strike Price Expiry in Days Implied Volatility Risk free Interest
5 6 7 8 9 10 11 12 13
Dividend Rate Expiry in Years d1 d2 nd1 nd2
B Value
C
D
5295.55
CE price
5100 27
CE Delta
E *(type in formula) *(type in formula)
0.19200
0.09
PE price
0.21
PE Delta
*(type in formula) *(type in formula)
0.07397 0.57666 0.52444 0.71791 0.70001
The column E contains the formulae for option prices and Deltas so you might color these cells differently from the input cells, and also lock the cells after typing in the formulae so that these are not erased accidentally later. Now the call option price is calculated by typing in the formula at cell E2 as: “=IF(ISBLANK(B7),B2*B12-(B3*EXP(-B6*B9))*B12, EXP(-B7 * B9) * (B2 * B12) - (B3 * EXP(-B6 * B9) * B13))” The Greek Delta for the call option is yielded by the formula given below in cell E3: “= B12*EXP(-B7 * B9)” The rows numbered 6 and 7 in column E contain the formulae for put option prices and Deltas, and the put option price is calculated by typing in the formula at cell E6 as:
“=IF(ISBLANK(B7),EXP(-B6*B9)*B3*(1 - B13) - B2 * (1 - B12),EXP(-B6 * B9) * B3 * NORMSDIST(-B11) - EXP(-B7 * B9) * B2 * NORMSDIST(B10))”
The Greek Delta for the put option is yielded by the formula given below in cell E7: “= (B12 - 1) * EXP(-B7 * B9)” Now compare your results with the table below, and if the figures match perfectly, you have the Black Scholes option pricing model right there for you in your very own spreadsheet!
1 2 3 4 5 6 7 8 9 10 11 12 13
A Parameters Spot Price Strike Price Expiry in Days Implied Volatility Risk free Interest Dividend Rate
B Value 5295.55 5100 27
Expiry in Years d1 d2 nd1 nd2
0.07397 0.57666 0.52444 0.71791 0.70001
C
D
E
CE price CE Delta
196.77 0.707
PE price PE Delta
49.01 -0.278
0.19200
0.09 0.21
You may now tweak the input values by typing in other figures for IV or number of days to see how the Put option price varies. Notice how the price and delta changes with days left to expiry. Play around and get a feel of the option price changes with IV, spot price of underlying and days to expiry. While you may not write anything in the cells for option prices or the Deltas, since these contain formulae that are derived from the inputs in cells B2 to B7, you can use the ‘Goal Seek’ function available in the MS-Excel orksheet under the ‘Tools’ section. As an example, if you see the price of a call option of strike 5100 being quoted at say, 190, and the spot value of the underlying at 5290, with 24 days left to expiry, you can change the relevant inputs in cells B2 to B7, and then use the ‘Goal Seek’. In the box that appears on selecting the ‘Goal Seek’ tool, set cell: E2, To value: 190 ( CE value) By changing cell: B5. The worksheet would then perform a number of iterations to return a value of Implied Volatility in cell B5. To help the worksheet along, you may have to type in a reasonably feasible value of IV in B5. If you have an absurd value of IV there, the goal seeking tool may return nothing.
Alternatively, you may type in various values of IV in cell B5 yourself until the desired call option value is seen in cell E2. The Delta for the call option ill then be calculated along with the CE value. You may also familiarize yourself with checking IV and Delta for various strikes and other call and put options prices being quoted on different days of the month. Since you would be writing (selling) options, it’s important to get a handle on IV and Delta. For the call options, an IV of greater than 21 % (0.21) is good enough to sell as higher IV means you are getting a good amount of money for this, while an IV of 13% or more is great for selling put options. Sometimes, you may not see such IVs but may have to go along anyway. Also, these thresholds are strictly sacrosanct. With more exposure to writing options over a course of time, you might arrive at your own thresholds that ork for you with other indices or stocks. The Greek symbol Delta is sensitive to the underlying asset’s price and when you see this more than 0.9, it may be time to square off positions and book profits or losses as the case may be. For put options, this would be a negative quantity in notation, but the same rule applies. With a Delta of 0.9 and approaching 1, usually during the last 8 days of a contract’s life, you may take home more than 80 percent of the maximum profits promised by the combination of the futures and options strategy that is explained in the next chapter. There are other Greeks that I may mention here only for information purposes: 1. Vega is the one that is sensitive to volatility, and 2. Theta is rather touchy about the time factor, and 3. Rho shows the change that responds to interest rate. For our purposes, we are quite content with the Delta as a guide to exiting positions. Vega and Theta are anyway redundant to us since we are directly incorporating the values of IV and time in our trading behavior.
The Black-Scholes equation primarily estimates the price of an option over time and Delta-hedging is its prominent handle to profit from hedging opportunities. In reality, being perfect in what it is, it is actually our equations that are only an approximate representation of that reality. There are many ideal assumptions in formulating any mathematical picture of reality and we have to bear with those imperfections as long as our purpose in selection of hedges is achieved satisfactorily. Keeping this in mind, let’s put the Futures and Options trading strategy in place.
I made a fortune getting out too soon. -John Pierpont Morgan
4. The Simplified Trading Strategy As you look at the MHAF chart, you might notice either a bullish trend already in progress or an ongoing bearish trend. Your trading skill dictates that you take a new position only at the start of a trend, bullish or bearish. And when you take a fresh position, the basic rule you must follow is the Contrary Positions Rule as below:
The Contrary Positions Rule (CPR) For every position created in futures, create an equal and opposite (contrary) position in options for the current calendar month contracts. Since we are riting options, and want the options to expire in the month, in order to profit from time decay and falling implied volatility, the calendar month should be the same as the delivery month, or in any case, the expiry day should not be more than 34 days away from the day you are creating new positions. The expiry day should also be not less than 13 days from the day you are executing a new strategy. Thus, if you have gone long in futures, which is a bullish position, go short in the nearest (higher than the futures price) out-of-the-money call options, being a contrary bearish position; or, if you have gone short in futures (bearish scenario), also go short in the nearest out-of-the-money ( lower than the futures price) put options ( which is a bullish position). Make sure that the number of lots in futures and options are such that quantity-wise, the positions are equal. As an example, the DJIA ($10) Dow Futures have a multiplier of 10, so buying one lot of Dow Futures has 10 Dows as its lot size, but the DJX (1/100) call options has a multiplier of 100, hich makes it one unit of DOW index. To make the positions equal, you ould be buying 1 lot of Dow futures and selling against it 10 lots of DJX call options. The Nifty futures and options size has the same multiplier of 50; hence 1 lot of Nifty futures equals 1 lot of Nifty options. So, as you create positions in Futures and Options, pay attention to the multiplier for each that decides the lot size. In the example below, we will consider the lot size to be equal for both futures and options, to make understanding easier. Each action at the start of a trend should then comprise of creating contrary positions. Furthermore, if the trend changes from bullish to bearish or from bearish to bullish, the same CPR applies.
Now, let’s see how this simple rule manifests into your derivatives trading portfolio in the two possible initial scenarios.
The advent of a bullish scenario At the beginning of a bullish trend, you would create BUY position with one lot of futures, as a long position, and also simultaneously create one lot of SELL position of the nearest OTM call options. This combination is known as a covered call, only here the calls have covered by futures instead of stocks. To calculate the maximum profit potential (let’s abbreviate this as MP from now on for brevity) from such a position, assume that you bought the futures at a price of F1 and sold call options of strike CS at a premium of CP1, you might use this simple math: MP = (CS – F1 + CP1) This is the maximum profit you can hope to get, even if the index or stock price goes on to the moon or above. The CPR has effectively limited your profit potential to this level and worked to inhibit greed besides robbing you of your optimism bias. The nearest sky is the limit for now. Continue to hold on to the positions as long as the trend continues, and book profits when the option’s Delta approaches the value of 0.81 to almost 1. This ill yield most of the estimated maximum profit, if not all, in your trading account. Although the sky, in this case the strike price and above, is the limit to maximum profits, remember that the sky is vulnerable. Quite like Chief Vitalstatistix of the Gauls in those Astrerix Adventure comics, you have only one thing to fear: that the sky may fall on your head tomorrow. So if the trend does not remain bullish for long, and the sky does fall tomorrow or on any other day, you have to pay attention to the breakeven
(BE) point. This can easily be calculated as below: BE = F1 – CP1 In the event that this breakeven point is violated, you would need to change the positions accordingly. So this point will now also serve as the reversal point (RV) for your positions from bullish to bearish. Hence, RV = BE = F1- CP1 In such a scenario, you had long futures and short call options initially but as the reversal point is breached, you would be selling futures and selling OTM put options. This action squares off your long futures leaving you with nil positions in futures, and short OTM call and put options, which is called a short strangle. To profit from the imminent bearish scenario, you must now also have short futures, so sell futures again, this time to have short futures in your trading account, and again, compelled by the CPR, also sell another lot of OTM put options simultaneously. The combined action at the Reversal Point is then actually selling two lots of futures, at a price of say, F2, and also selling two lots of Put Options at a price of say, PP1 and of a strike say, PS. Now, with the first reversal in trend, you have the following three positions in your derivatives trading portfolio: 1. One lot of short OTM call options; 2. One lot of short futures; and 3. Two lots of short OTM put options; You can now revise the maximum profit potential and break-even or reversal points. The calculations for these are now a bit more complex. Once you know the maximum profit levels and reversal points, you can prepare to either book profits when the put option’s delta exceeds -0.55, or if the maximum profit strike level is reached during the last 13 days of expiry date
or reverse positions prior to that if a reversal point is hit. The maximum profit potential on the downside (MPd) is now calculated in two steps as follow: 1. Loss on squaring off futures = L1=(F2 - F1) ( a negative negative quantity) 2. MPd = (F2 – PS + 2*PP1 + CP1 + L1) This maximum profit as an ideal objective would be available only if the index closes at the put options strike of PS on the day of expiry. To check the amount of profits you could make if the underlying index or stock price closed at a price of say EX, on the day of expiry, you may replace PS by EX in the above formula to get realizable profit at EX, as below: Realizable Profit (RP) = (F2 – EX + 2*PP1 – 2*PP + CP1 + L1), here EX is the spot value of the underlying as closing price on the day of expiry, and PP is given by (PS - EX) if EX is less than PS, but is nil if EX is equal to or more than PS. PP appears because this is premium you would have to pay back in case the underlying asset’s price falls below the put option’s strike price. If the underlying asset’s price goes below the PS level, the profit potential ould drop since a certain amount of premium received on the written put options would have to be paid back. In fact, if the underlying falls a lot, the situation may even turn up a loss, since you have two lots of put options sold, against one lot of short futures. So, there should be a breakeven point somewhere below the strike price level. This breakeven point on the downside (BEd) can be simply calculated as below: BEd = PS - MPd In a scenario when the underlying has taken this BE level rather rapidly and
there are still some days left to expiry, you would have no choice but to square off all positions because trying to cover the extra one lot of short put options by selling more futures or continuing the strategy any further would only add to the chaos. Any such further action at this point might only increase losses or decrease available profits depending on the number of days left to expiry and the resultant implied volatility. The best way out is stay alert to the delta value -0.55 on the put options you have sold and square off all positions once you see this delta level. This is because only 50 percent of the put options are covered by the short futures and a delta beyond this level ould decrease available profits. So, keep an option delta of -0.55 as the optimum level to exit all positions. However, you might try and shift strikes of both call and put options downwards, keeping the futures as they are. Just make sure that the next lower put option delta is less than -0.34. Depending on the premiums available, you can recalculate the exit point on the downside and the reversal point on the the upside. If these points are comfortably comfortably away, you you can consider shifting downwards. Alternatively, you may also sell one more lot of futures and at the same time, sell an equal one lot of put options, at the OTM put strike if this strike is reached very quickly by the spot index . This would bring the ratio of futures to options at 2:3, instead instead of the previous 1:2. This action will result in shifting the exit point a bit further away, and reduce the possible loss from the position, while increasing the profit potential. With this new ratio of futures to options, you can stay in the game until you see a delta of -0.67 for the put options. Try and re-calculate the maximum profit potential, the exit point and the reversal point for this scenario from the new futures price and option premiums. That That should be simple simple enough for you by now. But get out while you can, with perhaps just a small loss if you see the BEd being breached, or shift strikes downwards downwards if the premiums premiums on the the options show workable limits on the upside and downside breakeven points. Again, a good exit plan would be to square off all positions and book
hatever available profit (or a small loss) is left on the downside when there are less than 13 days left to expiry and the underlying index or stock price is near the maximum profit level of the put option strike. To calculate Realizable Profit on any other day prior to the expiry e xpiry day, you ould have to subtract the premiums to be paid when you square off : If the price of futures where you square off is F, the premium paid back on the call options is CP and the premium paid back on the put options is PP, then : RP = (F2 – F + 2*PP1 – 2*PP + CP1 - CP + L1), So, remain alert to the possibility of exiting during the final 13 days of expiry hen you can book about 80 percent of MPd or when the Delta for put options is seen from -0.80 to -1. Remember to check the Option pricing model for the Delta value and IV regularly. On the upside, since you now have one lot of short futures, a reverse situation on the upside too can result in a breakeven or reversal point. If the underlying begins to rise, you you would profit profit from the the short put options, options, but would would begin taking a loss from the short futures until a point where the loss from the future is more than the premium received on the written put and call options. This breakeven point on the upside (BEu) is easy enough to calculate as given below: BEu = PS + MPd Notice that there are now two breakeven points where you you may have to take action and one maximum profit potential level where you may square off the entire portfolio. Continuing our upside scenario further, if the upside reversal point is breached, you must must buy back the short futures futures at a price of say F3, F3, and by the the CPR dictation, you must also sell an equal lot of the same OTM strike call options that exists in your portfolio, at a price say CP2. Again, for the now
bullish scenario, you have to buy futures to create a long position in futures, and simultaneously also sell an equal amount of call options. So, at the upside reversal point, BEu, you would actually be buying two lots of futures at a price of say, F3 and selling two lots of call options at a premium of say, CP2. You would then have the following open positions in your trading account: 1. Three lots of short OTM call options; 2. One lot of long futures; 3. Two lots of short OTM put options. The calculations for maximum profit potential levels and reversal points are now slightly more complex but still involve these two steps: 1. L2 = F2 – F3 ( a negative quantity) 2. MPu = (CS – F3 + 2*PP1 + CP1 + 2*CP2 + L1 +L2) Now, the breakeven point on the upside can again be simply calculated as: BEu = 0.5*MPu + CS , (half of the Max Profit since futures to call options are now 1:3) hile the breakeven point on the downside is : BEd = CS – Mpu. Again, this maximum profit potential is only achievable under the ideal condition that the index or stock underlying price closes at CS on the day of expiry. So, if you can realize 80 percent of this maximum profit or if you see the call option delta nearing 0.55, you may square off all positions to bank your profits. Although only one third of the call options are now covered by the futures, you can still keep positions until a higher level delta of 0.55, since you also have 2 lots of put options sold to make up the loss for that extra bit of higher delta. In case the call option’s OTM strike is reached very quickly by the spot
index, you might buy one lot of futures, to bring the ratio of futures to options to 2:3 from the earlier 1:3, if this seems feasible when the amount of premium is rather high on the options. This action will help raise the upside breakeven point a little higher so you would have more days for the strategy to work in your favor. It will also enable you to hold to a higher value of delta of 0.67. You must now be able to calculate fresh maximum profit potential and the exit points both on the upside and downside, and remain alert to to the possibility of these new figures being hit anytime. The exit plan now should entail squaring off all positions in any one of the following conditions: 1. About 80 percent of MP is realizable, or 2. The Delta of relevant option is nearing 0.55, or 3. The maximum profit potential level near the relevant strike price is seen when there are less than 13 days left to expiry. 4. Any one of the breakeven points MPu or MPd on the upside or downside is breached, and shifting strikes downwards, or altering the futures to options ratio, or reversing positions upwards is not feasible. So far, you have acted three times during the same calendar month’s contracts. The fourth action should always be to square off all positions if a further breakeven point is breached. Take whatever profit or loss has accrued and wait for the next month’s contract to start afresh. Now, just to clarify the trading strategy further, consider the alternative initial scenario of a bearish trend, that is, if the modified Heikin Ashi chart (MHAF) triggers suggest a bearish scenario at the start of a calendar month.
The advent of a bearish scenario The first action in this case would be to sell one lot of futures and to sell one lot of OTM put options. Having calculated the breakeven or the reversal point and maximum profit potential, you would wait until more than 80 percent of the maximum profit is available to square off or change the portfolio in case the reversal point is breached.
If the reversal point on the upside is violated, you may square off the short position in futures by buying the futures, and as per the CPR guidance, also sell an equal lot of OTM call options. To take advantage of the now bullish scene, you may buy one lot of futures and also simultaneously sell one lot of the same OTM call options. With this second leg of positions creation, you now have the following in your derivatives portfolio: 1. One lot of short OTM put options; 2. One lot of long futures; and 3. Two lots of short OTM call options. You can now calculate the maximum profit potentials and breakeven point on the upside and the reversal point on the downside. I will not burden you with more formulae here since these would be quite similar to the ones above with an obvious deviation for the now complementary situation. The formulae will appear simpler as you walk through the twelve months of actually trading the Nifty in the next chapter. Remain alert to the possibility of squaring off all positions if more than 80 percent of the maximum profit potential is available at any time of the day, or if the call option’s delta hits 0.55, or the maximum profit potential level is hit hen there are less than 13 days left to the contracts’ expiry, or if the breakeven point on the upside is hit pretty soon. If, however, a reversal point is breached on the downside, you would reverse the futures from BUY position to SELL position, by selling once to square off the long position and selling one lot again to create a short position. Simultaneously, you would also sell two lots of the same OTM strike put options. With this third action, you would now have the following open positions: 1. Three lots of short OTM put options;
2. One lot of short futures; and 3. Two lots of short OTM call options. (Remember that since the ratio of futures to put options sold is 1:3, the exit point on the downside is calculated by subtracting half of the MPP from the put option’s strike). Now that three creative actions to be taken are exhausted, the only remaining fourth action would be to square off all positions as per the Exit Rule, unless shifting strikes on the downside appears feasible depending on the next exit and reversal points that can be re-calculated with the available premiums on the new strikes, or increasing the ratio of futures to options appears feasible. I know this may seem a bit daunting at first, but be assured that once you take the actual trading walk in the next chapter; the whole strategy would seem like a walk in the park. Let’s now formulate the second rule of this simplified trading strategy:
The Exit Rule A. Square off all positions if more than 80 percent of maximum profit potential can be booked on any day of the contracts’ month, or if the Delta of the relevant option is nearing 1 from 0.8. B. Square off all positions if the breakeven point is breached from the second leg of trading action, or if the option delta hits 0.55 ( or -0.55 in case of the covered put options). C. Square off all positions if reversal point is breached for the third time. The fourth leg of action is always getting rid of all open positions. D. Square off at the maximum profit potential levels if the level is seen at any time during the last 12 days of the contracts’ life, i.e. when less than 13 days are left to expiry. These rules will also be pretty obvious to you as you go through a real-life example next, so don’t be intimidated by these for now.
The Three Acts Play Summarized Act I: The curtain raiser is creating contrary positions in futures and options, either with a bullish or bearish view. Act II: The derivatives trading drama is carried out to the climax of either reaching the maximum potential profit level of 80 percent or of taking actions at reversal points. Only two reversal actions are permitted, just like in a play here a crisis and a disaster situation emerge at different places in the second act while the third act usually offers a solution. Act III: Curtains are dropped by squaring off all positions if either maximum profit potential level is hit during the last 13 days of contracts’ lives ( a happy ending), or relevant delta is breached, or a third reversal point (a tragic end) is hit. With these Three Acts of the trading play outlined and rehearsed well, let’s see how the drama unfolds for the next twelve months by walking the talk in actually trading the S&P CNX Nifty.
Concentrate your energies, your thoughts and your capital. The wise man puts all his eggs in one basket and watches the basket. –Andrew Carnegie.
5. Walk the Talk The S&P CNX NIFTY is a basket of the 50 most actively stocks on the NSE, India. Let’s watch that basket through the past twelve months. Since the lot size of Nifty futures and options is the same, i.e. having the same multiplier, and the delivery cycle is monthly with every calendar month having the same delivery month contracts, this index is ideally suited to serve as an example of the CPR F&O strategy.
The Month of April-2012 It is rather important that you initiate contracts for the month when a fresh trend, either bullish or bearish, has just begun for the month, and this is perhaps the only time that you will look at the modified Heikin Ashi chart (MHAF) triggers already created by you as a spreadsheet from the earlier book titled “The Modified Heikin Ashi Fibonacci Trading System”. I will reproduce here the triggers as calculated from that spreadsheet: Date 21Mar 22Mar 23Mar 26Mar 27Mar 28Mar 29Mar 30Mar 2Apr 3Apr
NIFTY
Buy
StLoss
Sell
StLoss
5267.2
5372.35
5256
5364.95
5361.1
5385.95
5205.65
5228.45
5255.65
5312
5220
5278.2
5274.35
5274.95
5174.9
5184.25
5242.95
5277.95
5184.65
5243.15
5303
5231
5207
5279
5231.7
5236.55
5169.6
5194.75
5302
5238
5214
5278
5145.95
5194.3
5135.95
5178.85
5289
5228
5204
5265
5206.6
5307.1
5203.65
5295.55
5237
5162
5138
5213
5296.35
5331.55
5278.8
5317.9
5250
5192
5168
5226
5353.2
5378.75
5344.45
5358.5
5270
5218
5194
5246
4Apr 9Apr 10Apr 11Apr 12Apr 13Apr 16Apr 17Apr 18Apr 19Apr 20Apr 23Apr 24Apr 25Apr 26Apr 27Apr
5328.65
5338.4
5305.3
5322.9
5334
5282
5258
5310
5282.5
5287.9
5228
5234.4
5371
5309
5285
5347
5254.1
5255.8
5211.85
5243.6
5342
5286
5262
5318
5209.45
5263.65
5190.8
5226.85
5324
5259
5235
5300
5246.75
5290.6
5246.75
5276.85
5284
5229
5205
5260
5255.7
5306.75
5185.4
5207.45
5317
5235
5211
5293
5190.6
5233.5
5183.5
5226.2
5300
5242
5218
5276
5266.6
5298.2
5208.35
5289.7
5276
5205
5181
5252
5320.7
5342
5293.45
5300
5267
5210
5186
5243
5320.6
5342.45
5291.3
5332.4
5300
5242
5218
5276
5313.95
5336.15
5245.45
5290.85
5343
5271
5247
5318
5277.40
5310.55
5187.15
5200.60
5361
5278
5254
5336
5215.90
5232.35
5180.35
5222.65
5327
5268
5244
5302
5222.20
5236.10
5160.65
5202.00
5306
5240
5216
5282
5214.75
5215.60
5179.05
5189.00
5276
5222
5199
5252
5189.00
5223.05
5154.30
5190.60
5266
5202
5178
5242
Table 3 The MHAF chart for that time is shown here for your reference:
The bullish candle and trigger on 30-Mar becomes the starting point for your trading strategy. Since you are buying futures and also selling call options simultaneously, it would not matter much if you executed the trades when the past one hour’s average price crossed the bullish trigger of 5237, or waited until nearly closing time. This is because if you bought the futures at a lower price during the day, you would be receiving less premium on the call options hen the underlying was not as high as at closing time and vice versa if you bought the futures at a higher price near closing time, you would be receiving higher premium on the call options then. It’s always prudent to wait until near closing time in this case, say about 1015 minutes before the closing bell since by that time you are apt to avoid the volatility of the day and the price discovery mechanism is already over, confirming the advent of the bullish trend. As the Nifty closes near 5295, the bullish trend wants you to buy Nifty futures, and presuming we are buying near the close, we now have an open position in Nifty as below: BUY Nifty-Futures-26-Apr-2012 at 5327. (Let’s presume here that you bought somewhere between the closing and the last traded price – LTP). You may retrieve the historical values of both futures and options from the derivatives archives available at nseindia.com.
Here are the tables for the prices of futures and options that you would need to refer to during this trading walk for the month of April:
NIFTY Futures
Date 30-Mar12 2-Apr12 3-Apr12 4-Apr12 9-Apr12 10-Apr12 11-Apr12 12-Apr12 13-Apr12 16-Apr12 17-Apr12 18-Apr12 19-Apr12 20-Apr12 23-Apr12 24-Apr12 25-Apr12 26-Apr12
High
Low
Close
LTP
APR-26-2012 Underlying Value
5,246.00
5,346.90
5,239.00
5,333.25
5,322.00
5,295.55
5,300.00
5,372.00
5,300.00
5,350.65
5,357.75
5,317.90
5,377.00
5,402.00
5,367.80
5,383.25
5,383.10
5,358.50
5,361.00
5,361.00
5,324.75
5,344.55
5,349.05
5,322.90
5,294.00
5,301.90
5,245.05
5,253.00
5,252.25
5,234.40
5,261.15
5,277.50
5,226.00
5,266.15
5,264.40
5,243.60
5,224.00
5,292.25
5,203.15
5,251.35
5,267.00
5,226.85
5,274.70
5,308.40
5,260.00
5,290.65
5,283.10
5,276.85
5,303.90
5,330.00
5,195.20
5,221.10
5,211.00
5,207.45
5,188.90
5,258.00
5,182.00
5,248.45
5,257.00
5,226.20
5,249.70
5,325.30
5,221.15
5,319.60
5,321.00
5,289.70
5,347.00
5,364.45
5,312.25
5,322.70
5,315.00
5,300.00
5,330.05
5,366.15
5,312.85
5,356.20
5,364.00
5,332.40
5,310.00
5,353.55
5,000.00
5,302.00
5,304.80
5,290.85
5,297.00
5,314.65
5,182.25
5,198.60
5,184.00
5,200.60
5,199.80
5,238.90
5,186.20
5,224.35
5,229.65
5,222.65
5,220.00
5,235.40
5,153.40
5,198.60
5,196.50
5,202.00
5,221.15
5,221.15
5,174.95
5,186.65
5,189.20
5,189.00
Open
Table 4 Now, as long as the Nifty continues to rise, you would make profits setting your target price for Nifty near the initial resistance that Nifty may face on its
uptrend as seen from your MHAF trigger table (not shown above). If you have bought a single lot, comprising of 50 futures, and the Nifty reached 5484 as a supposed target level, you stand to make a profit of 157*50 = (5484-5327)*50 i.e. 7850 units per lot. But what if Nifty takes a downturn tomorrow, and decides to pursue a bearish target of instead? After all, the market has an uncanny sense of knowing what trade you have taken, and doing quite the opposite! Not trusting the market, and in order to save your face (and money), you might also take a contrary position along with your bullish position. So to create a short position in Nifty, consider selling Call Options. Since the nearest OTM strike relative to the futures price of 5327 is 5400, you might sell Nifty calls of strike 5400 which would give you 84 points per lot. Notice that adding this premium value to the strike price of the call option gives the figure of 5484 which is very close to a reasonable resistance level proposed by your spreadsheet. You can see this premium was available at the time from Table 1 shown in the section on ‘Call option as a bet’ in chapter 2. Somehow, other market players have already sensed this to be a highly probable target as they are willing to pay you this premium already. Now, you have two open positions in your portfolio that are contrary to each other, because if the Nifty does reach 5484, you stand to make a profit of 7850 on the long futures, and lose no points on the call options, since you ould have to pay back 84 units on these options for which you had received 84 units. So, the net profit you would make if Nifty closes at 5484 by expiry date, (26-April-2012) is 157 units. Fair enough, if Nifty does indeed do that. You may calculate the maximum profit you could make with these open positions using the formula:
MP = (CE strike-futures price) + premiums received on CE = (5400-5327) + 84 = 73+84 = 157. How much you would make if the Nifty stays at the level where you bought the futures, i.e. the spot value of the Nifty closes at 5327 on the close of the expiry day? Easy enough to estimate that you will not make any money on the futures but get to keep all the money on the call option sold, so that’s still a profit of 84 units, even if the index does not move. Let’s now calculate the break even point, where you do not make any money. This would be simply the price where you bought the futures minus the premium you received for selling the call options. The break-even point can be found as below: BE point = Futures price – premium received = 5327 -84 = 5243. This seems to be a very important figure for your open position, and should serve as a reversal point. If you do see this value of 5243 being quoted for the Nifty spot, you should be reversing your futures position from BUY to SELL. You now have two critical values for the Nifty spot to look out for: 1. The target value of 5484 or above and when the Delta for the call options is nearly 1 is where you can hope to get the maximum profit, and 2. The reversal value of 5243, where you would reverse your portfolio. With this reversal point established, you no longer need to look at the MHAF chart or stop-loss figures to reverse your positions. The F & O market has decided the reversal point for your positions.
The next trading day, 2 nd April shows the Nifty to be within these two values and so you let your positions be as they are. The 3 rd and 4th April also keeps you in the position, being well within the limits set by your estimates above. The 9th of April finally spurs you into action as the Nifty dips below your exit value of 5243 towards the close of the day. Now, you might square off the Nifty futures by selling the lot you had bought. The selling price for the futures near the closing is 5252 and this has turned into a loss of 75 points for you (5252-5327). If you were to now also square off your sell position in call options by buying back the options at a premium of 36, you stand to gain 48 points here. So, by exiting both your positions at the Nifty spot of 5235, you have actually taken a loss of only 27 points on the combo. However, following the Contrary Positions Rule, you would be selling futures twice, once for squaring off the earlier BUY position, and then selling again to create a SELL position in futures. This would imply that you should sell two lots of Put Options of target strike of 5100, since the CPR rule wants you to create a contrary sell position in put options for every lot of futures sold. You are choosing a strike that is a little further away from the futures price since you are selling two lots of put options. This results in a breakeven point on the downside that is comfortably away. If you did, you just received a premium of 44 on each lot, giving you 88 points in all. (Refer to Table 2 in the section on ‘Put Option as a bet’ of chapter 2 to see the put options premiums). What is the maximum profit that you now hope to achieve with these positions? Note that you now have the following open positions: SELL 50 Nifty-Futues-April-2012 at 5252 SELL 50 Nifty-CE-5400-CE at 84
SELL 100 Nifty-PE-5100-PE at 44 So, the maximum profit for you would now accrue at the strike value of 5100, as follows: MPd = (F2 – PS + 2*PP1 + CP1 + L1) = 5252-5100 + 2*44 + 84 -75, = 152+88+84-75, = 249. Isn’t this even better than the earlier combo that had promised you a maximum profit 157 units at the start of a bull trend?! Could the mice anticipate that? Going through the motions of the calculations again for this combination, you note that if the Nifty closes at the spot value of 5252 where you had sold your futures, you would still make a profit of 97 ( premiums received on put and call options, minus the loss already taken on the long futures). Compare this to the initial combo where you would have taken of profit of 84 units, if the Nifty had stayed at the value of futures bought price. You are now actually in a slightly advantageous position because the Nifty moved contrary to your expectations!
Next, you may calculate the breakeven and reversal points in case Nifty decides to move away from your positions. There are now two breakeven points because you have a short strangle created on the options. On the downside, you will be taking maximum profits at the put strike value and then decreasing profits since there are two lots of put options sold. You can calculate that on the downside, the profit from your peculiar combination ill decrease linearly to a zero at Nifty spot of 4851, and turn to an increasing loss thereafter. This figure can easily be calculated by subtracting the maximum profit
available at the put strike from the strike itself, or as already shown in the section on ‘Advent of Bullish Scenario’ of the previous chapter : BEd = PS – MPd Thus, on the downside, the profits would shrink to null at a value given by (5100-249) that is 4851. The critical breakeven figure for this combination now stands at 4851 on the downside when you would have to reluctantly square off all positions and take a small loss. Since you also have a short call option position on the upside, you would have to check the spot value of Nifty that would turn this combination into a loss, and where you might reverse your open position in futures. The critical reversal figure for this combination on the upside stands at 5349, after which the combination begins to make increasing losses. Again this can be calculated simply by adding the maximum available profit of 249 to the strike value of 5100 which returns the maximum profit. Thus, reversal point on the upside comes to: BEu = PS + MPd = 5100+249 = 5349. As it turned out, these two critical values were never hit by the spot close of Nifty on any day during the life of the contracts, and the Nifty closed at 5189 on the expiry date of 26-April-2012. Using the Realizable Profits formula, you can calculate the total profit achieved by replacing the put strike value PS by the closing value of Nifty on the expiry day. Realized Profit (RP) is calculated as:
RP = (F2 – EX + 2*PP1 – 2*PP + CP1 + L1), here EX is the spot value of Nifty as closing price, and PP is the premium to be paid back if the underlying asset’s price fall below the strike price of PS, but is nil if the underlying asset’s price is equal to or more than PS. In this case of the month of April 2012, RP = (5252 – 5189 + 2*44 – 2*0 +84 – 75) = 160. The CPR trading strategy shows a total profit of 160 points for all your open positions combined at this closing value of 5189. Both the call and put options expired worthless, good for you, as you got to keep all the money received on the options, while taking a loss of 75 points on the long futures and a profit of 63 points on the short futures. Compare this profit obtained by the derivatives strategy to the simple trend following plan of entering and exiting to reversing positions in plain futures. Trend following the MHAF triggers through acting at buy, stop-loss and sell triggers, you would have made 60 units of profits, taking six trades in all. Three of these trades resulted in profits, while the rest three turned sour. This ould also have entailed entering and exiting trends at the right time of the day and keeping yourself awake throughout those trading days. Following your strategies by calculating reversal and breakeven points in advance and simply acting near the close of the day not only gives you greater profits but also saves you the stress of carefully watching the index all day long. Hasn’t life gotten much easier now?
The Month of May-2012
As the derivatives for the month of April expires on the 26 th, you look forward to the month of May. The downtrend on the modified Heikin Ashi chart continues and so it is best to wait for the start of a fresh trend to enter into a strategy for the new month. Remember you are allowed only three actions in a month, so please do not squander away one action by getting into an already going on trend. Sure enough, on the 30 th of April, the trigger on your spreadsheet for a bullish trend appears, and so you create a long position in futures near the close of the day, buying a single lot of futures at a price of 5268. (Please appreciate that in order to not fill this book with too many tables and charts, I will presume that you have your MHAF spreadsheet handy and can see the chart and triggers to initiate trades. Also, the futures prices and option prices are as accessible to you as to me at the historical prices section at nseindia.com, so I need not make this section any heavier than it already is by showing all those tables again for every month). Again, not trusting the market too much, you also sell call options of an OTM strike of 5400. You could also choose to sell the strike of 5300, but that ould be too near to the futures price and reduce your maximum profit potential somewhat. As a thumb rule, try and keep the strike price at least 50 points away from the futures price at the time of initiating the trading strategy. Writing this CE of strike 5400 would give you 46 units in your account that day. (refer to the historical archives at nseindia.com if you need to verify this). Now, Maximum available Profit = (5400-5268) +46, = 178. While the reversal point is calculated as: =5268- 46, which is 5222. Now, the stop-loss on the MHAF sheet reads 5178, which seems a more
comfortable exit point than the one dictated by selling 5400 CE options. But this is a trailing stop-loss and you might expect this exit to approach the reversal point suggested by the options strategy. If you calculate the implied volatility for this strike and option price, you ould find that this IV is 19.95 percent which is somewhat low but may work for the strategy. The Maximum Profit is then fixed at 178, while the exit point for this combination of covered calls strategy is at 5222. So, armed with these critical values of target and exit points, you sit back happily to watch the play of the markets. The 3rd of May-2012 sees you waking up alert as the reversal point for your open position is breached with Nifty dipping to 5188, prompting you to reverse your positions. You may now sell the existing long position in futures near the close of the trading at 5203, taking a loss of 65 units, and sell another lot to create a short position in Nifty futures at the same price. To act contrarily to your selling two lots of futures, you also sell two lots of put options for a strike of 5000 which is near to the short target of 4982 as shown on your MHAF spreadsheet. Again this strike is also a little further off since you are going to have twice the lot of short options on the downside than the upside. You receive 38 units for a lot which is a sum of 76 units in your trading account. Using the formula for calculating Maximum Profit and the two breakeven points on the upside and downside, you get: Maximum Profit if Nifty closes at 5000 on the expiry day = 260, and Exit point on the downside = 4740, while Reversal point on the upside = 5260.
(Aren’t these pretty simple calculations now?) As you keep monitoring the rise and fall of the Nifty, remain alert to these critical values. The extreme points were never hit by the index during the life of the open positions in your trading account, and finally on the day of the expiry, the Nifty closed at 4924. You could have taken the available profits when the Nifty spot reached the value of MPP level of 5000 during the last 13 days of contract’s life, but let’s see what the combination reveals if you held on to the position until the expiry day. Putting this closing of the spot Nifty in your formula for Realizable Profit calculations, you can see that you took a profit of 184 on the combination strategy of a short strangle and mildly covering the downside with short futures. RP = (F2 – EX + 2*PP1 – 2* PP + CP1 + L1) = (5203 – 4924 + 2*38 – 2*76 + 46 – 65) = (5203 – 4924 + 76 – 152 + 46 – 65) = 184. Now, comparing this figure to the MHAF trading plan, you note that you might have taken a profit of 236 with five trades, two of which had resulted in small losses. Of course, this would have meant remaining alert throughout the days of the month, and acting at or near the trigger points suggested by your spreadsheet. On the whole, so far, you have made more money with the derivatives strategy for the two months than by following the MHAF simpler plan. Let’s now see what the back testing reveals for the month of June-2012.
The Month of June-2012
The downtrend that begun on 31 st May for the Nifty continues till the 5 th of June, so you patiently wait for a fresh trend to appear before creating new positions in the index. The 6th of June sees a powerful white candle and the trigger for a bullish trend is breached, inspiring you to take a long position on Nifty futures at 4977 near the close of the day. The upside target or resistance suggested by the spreadsheet being 5065 implies that you also write the call options strike 5100, taking in 55 units in your trading account. You may also find out from your Option Pricing worksheet that the implied volatility for this strike is 22.6 which is good enough to write. Now, you can easily calculate that the maximum profit afforded to you is: MP = (5100-4977) +55, = 178. The exit point, also the reversal point for this covered call combination should then be: Exit point = 4977-55 = 4922. As you sit back, watching the ebb and flow of the market, the Nifty keeps rising steadily and falling back on some days but never breaching your exit point. Finally, with a close at 5149 on the expiry day of 28 th June, that was above the strike price of the call option, this single action resulting in the simplest of a covered call yields you the maximum profit available which is 178 units. Of course, you would be paying brokerages in your trading account as the trading exchange bills you for closing out the in-the-money options, but for our purpose here that is outlining trading strategies, we are neglecting this part in order to not complicate calculations. (Brokerages are pretty small these days, anyway). Let’s now compare this result to the simple trading plan of following the
MHAF pattern. For a total of six trades in this pattern, five turned out to be losers and only one returned a profit, resulting in a net loss of 45 points for the month. Well, your single covered call strategy came out quite on top this time.
The Month of July-2012 As you scan your MHAF spreadsheet, you notice that a bullish trend had actually begun on 29 th June, just a day after the expiry of June contracts on 28th June. Although the triggers seemed all right on 27 th June, the closing price was still around 5142, quite below the bullish trigger of 5155 on that day. Remember that for our back testing purposes, we shall presume that we are letting the exchange close our open contracts expire on the date of expiry, although you might have closed your position any time prior to 13 days of the expiry date or any other day when you noticed the Delta nearing 1 from 0.8. Also, following the simple trend following plan, we will compare the profits or losses accrued with the same initial position for our derivative strategy. Now, since a proper bullish trend ensued on 29th June, you should buy one lot of Nifty futures contract for July at 5293 near the closing trades of the day, and consider selling the call options for strike price of 5400 which was going for a premium of 54 units. Using the goal seeking tool on your Option Pricing worksheet, you estimate the IV for this option at 0.208. The IV for the 5300 strike call option priced at 95 is around 0.224. These are relatively high IVs, so you may consider selling any one of them. However, since the strike of 5400 offers better maximum profits and a reasonable reversal point, you may decide to go along with the 5400 CE. In any case, you are actually happier at reversal points since they tend to
increase your profit potentials! The critical values for maximum profit and the reversal point are then calculated as: MP = (5400-5293) + 54 = 161. Reversal point, in case the trend turns bearish = 5293-54, i.e. = 5239. Now the 12th of July turns bearish as the as the spot Nifty closes near 5235, quite below 5292, the trigger for selling the index, and just below 5239, the reversal point, prompting you to square off the long futures at a price of 5249, taking a loss of 44 points on the futures. As you sell the one lot of futures, you also take a contrary bullish position by selling put options. Further, to profit from the ensuring bearish trend, you may want to short futures and simultaneously sell put options as a contrary position. Checking the IV of the put options for strike 5100, you notice that the IV for this put option priced around 20 is just 0.127 which is quite all right for riting a put option. Although the bearish target on the MHAF spreadsheet suggests the strike of 5000, you may find the premiums for this put strike to be very low, so you decide to write the 5100 strike put options. As you create a short position in Nifty futures at 5249, you also sell two lots of put options of strike 5100 for a price of 20 units each. Now, you have made a loss of 44 points on the long futures but still hold the sell position in call options at 54 points, so you have not yet actually taken a loss on your initial combination. You can calculate that the maximum profit from this new combination stands at 199 points if the Nifty closes at 5100 on the expiry day. Again, you are relieved that your profit potential has actually gone up from the initial 161 to 199, simply because the index happened to disagree with your charts!
Further, you can calculate that on the upside your reversal point would be 5299 and on the downside, the breakeven or exit value exists at 4901. As the Nifty moves over the next few days, there is some anxiety on 19 th July hen you see a white candle on the charts, but the index did not breach the reversal trigger of 5299 on the close of that day. Sure enough, over the next days to the expiry date, the Nifty continued to be bearish and ended at 5043 on the closing bell of 26-July. If you did not close out your open position in puts during the day, the exchange and your broker house did, leaving you with a net profit of 142 points for the month. You can see how this profit is realized from the Realizable Profit formula as below: RP = (F2 – EX + 2*PP1 – 2* PP + CP1 + L1) = (5249 – 5043 + 2*20 – 2*57 + 54 – 44) = 142. Please note that this time PP has a value of 57 because the closing price of Nifty went below the Put options’ strike price of 5100, and so you had to pay back that difference on the short put options in your portfolio. Upon following the simple trading plan as dictated by the MHAF spreadsheet, you would have taken 6 trades, with three turning bad, but the rest three still managing to create a net profit of 129 points for you, that is still nearly equal but slightly less than the futures-options strategy.
The Month of August-2012 The 30th of July shows a clear bullish trend beginning with the closing price at 5199 well above the buy trigger of 5131 on the Heikin Ashi Fibonacci tables. The futures are priced at 5215, so the nearest strike of 5300 is a logical target
to write the short calls. These are priced at 53 indicating an Implied Volatility of 18.8 percent on the goal seeking scenario in the Option Pricing model. Being below the threshold of 21 percent IV, one lot of the call options needs to be sold to take a contrary position for the long futures. Now, the maximum profit from this combination is (5300-5215) +53 which comes to 138 points. The reversal or exit point is then 5162, which is as always the futures price less the option premium received in a bullish scenario. Following the movement of Nifty over the next days, this reversal point was never breached during the life of the futures contract. Perhaps you were half hoping that the index would take a downward turn soon enough, because the past few months have revealed that an opposite movement gives more profits to you than a monotonous single trend. Although, the bullish trend did reverse to a bearish scenario on the 27 th of August as observed strictly by the closing price during the entire month, your reversal point of 5162 was never hit. You could have booked your profits during the last expiry week of trading whenever you saw the Nifty hovering above the profit target of 5353. Even if you did not, and waited for the expiry day, you would still make a profit of 138 points, as the Nifty closed at 5315. Thus, you have made a net profit of 138 for this month of August -2012, with only a single covered call strategy in your portfolio. Comparing this to the trend following MHAF pattern, you note that the strategy has again turned out better because the MHAF trading plan of a total of four trades had actually turned up a loss of 23 points. So far, humans have indeed been outsmarting mice!
The Month of September -2012
I suppose I must break the monotonous flow of text for the last 4 months of trading. So here is the MHAF triggers table for the month of September. Date 31Aug 3Sep 4Sep 5Sep 6Sep 7Sep 8Sep 10Sep 11Sep 12Sep 13Sep 14Sep 17Sep 18Sep 20Sep 21Sep 24Sep 25Sep 26Sep 27Sep 28-
NIFTY
Buy
StLoss
Sell
StLoss
5298.20
5303.25
5238.90
5258.50
5388
5325
5300
5363
5276.50
5295.80
5243.15
5253.75
5354
5295
5270
5329
5249.15
5278.35
5233.20
5274.00
5336
5279
5255
5311
5243.90
5259.50
5215.70
5225.70
5330
5275
5250
5306
5217.65
5260.60
5217.65
5238.40
5305
5250
5226
5281
5309.45
5347.15
5309.20
5342.10
5264
5210
5187
5240
5343.65
5366.30
5343.45
5365.35
5298
5249
5225
5273
5361.90
5375.45
5349.10
5358.15
5336
5286
5262
5312
5336.10
5393.35
5332.10
5391.10
5366
5304
5280
5342
5404.45
5435.55
5393.95
5432.80
5369
5314
5289
5345
5435.20
5447.45
5421.85
5435.35
5399
5349
5324
5375
5528.35
5586.65
5526.95
5567.40
5393
5332
5307
5369
5631.75
5652.20
5585.15
5606.90
5460
5395
5371
5435
5602.40
5620.55
5586.45
5599.85
5538
5484
5459
5513
5536.95
5581.35
5534.90
5554.25
5597
5538
5513
5571
5577.00
5720.00
5575.45
5691.15
5584
5492
5467
5558
5691.95
5709.85
5662.75
5671.65
5615
5556
5531
5590
5674.90
5702.70
5652.45
5676.75
5660
5600
5574
5635
5653.40
5672.80
5638.65
5657.60
5689
5634
5608
5663
5673.75
5693.70
5639.70
5645.05
5692
5630
5604
5666
Sep
5684.80
5735.15
5683.45
5703.30
5679
5618
5592
5653
The downtrend from the last month continues into September until the seventh of the month. The index broke out into a bullish trend on this date, closing well above the buy trigger of 5264 at 5342, as witnessed on the MHAF triggers worksheet. You act to buy the Nifty futures at a price of around 5360. Looking at the going price of 46 for call options of strike 5400, you may calculate the IV as 16.95 percent from the Option Pricing model. This seems rather low and much below the threshold of 21 percent, and may not provide a good enough profit looking at its lower IV. Also, this premium gives a reversal point at 5314, which is far too near for comfort, and the maximum profit from the combination comes to only 86, hich seems rather meek compared to its peers of previous months. You can blame the lower IV of the call options in this month for that. Market players do not seem to be looking forward to a bullish run this time and so are not illing a high premium on the calls. But remembering that an opposite movement from an exiting trend always serves to increase the profit potential, you decide to go along with this covered call, hoping for a trend reversal. With this expectation you sit back to watch the progress of Nifty over the coming days, looking out for the index going below your reversal trigger. Alas! That never happens during the contract’s life cycle which ends the expiry day of 27 th September. The index closes at 5649, granting you a profit of 289 points on the long futures, but the short position in call options hands you a loss of 203 points so that your net profit for the month comes to the already predicted maximum profit of 86 points at the start of the bullish trend on 7th September. What were market players thinking? Why was there such low implied
volatility at the start of the bullish trend? Does low IV suggests a long bull run? I am afraid these questions cannot really be answered. We weave such complex webs that evolve around us in such mysterious ways as to leave us awestruck by our own creations. Nonetheless, this single covered call strategy has showered a net profit of 86 units for the month of September. Looking back at the MHAF worksheet, you might calculate that the candle following plan on the MHAF results in a profit of 293 points. The mice have won by a huge margin of 207 points this time around! Before getting on to the next half of the year, let’s summarize what we have achieved so far.
The First Half Results
Month April - 2012 May - 2012 June -2012 July – 2012 August - 2012 September - 2012
Strategy
Profit/Loss from Strategy
Profit/Loss from MHAF
160
60
Covered Calls followed by partly Covered Puts Covered Calls followed by partly Covered Puts Covered Calls Covered Calls followed by partly Covered Puts Covered Calls Covered Calls
184
236
178
-45
142
129
138 86
-23 293
Sum of Profit/Loss
888
650
We, the humans, have been doing a little better than the mice and rather consistently too in that so far we have not taken any loss in any month. Let’s walk through the rest of the year now.
The Month of October – 2012 The bullish trend of September continued in the first week of October, until the 8th day of October saw a reversal. The sell trigger for Nifty at 5706 was breached around a closing of 5676 for the day. This would prompt you to short Nifty futures at a price of 5700. To take a contrary call, you might now consider selling put options at the nearer strike of 5600. This is seen trading at a price 40 by the close of the day. Using the goal seeking function in your Option Pricing worksheet, you find that the IV for this option is at 12.4 percent, which is near the threshold of 13 for put options. But since the maximum profit from this combination works out to be 140 points, you decide to go along with it. The reversal point happens to be at 5740, which is quite near but remember
that if the trend does reverse to a bullish scenario, the maximum profit potential usually increases from the previous combination. As the Nifty progresses over the next days, you are only watching out for the reversal point of 5740 to be breached. This never happens as the Nifty stagnates in a narrow range of 5634 to 5729, finally closing at 5705 on the expiry day falling on 25 th October. This scenario has turned up a loss of 5 points on the short futures and a profit of 40 points on the short put options which expired worthless. Thus, a net profit of 35 points has accrued this month in your trading account. Let’s see how the MHAF trend following plan would have worked. From the triggers suggested by your Heikin Ashi tables during this time from 8th October to 25th October, you can see that all the four trades taken during this time resulted in losses totaling 168 points. Whew! The CPR trading strategy certainly worked pretty well to avert that huge loss for you this month.
The Month of November – 2012 This month is the only one of the twelve months that will compel you to act on the third leg as reversals happens twice during the same month. So just to make sure that you follow through the intricacies, I will reproduce here the MHAF triggers table for your careful perusal. Date 25Oct 26Oct 29Oct 30Oct 31-
NIFTY
Buy
StLoss
Sell
StLoss
5688.80
5718.75
5685.70
5713.60
5730
5674
5648
5704
5683.55
5697.20
5641.75
5663.85
5753
5690
5664
5727
5665.20
5698.30
5645.10
5665.60
5735
5672
5647
5709
5656.35
5689.90
5589.90
5597.90
5744
5666
5640
5718
Oct 1 Nov 2 Nov 5 Nov 6 Nov 7 Nov 8 Nov 9 Nov 12 Nov 13 Nov 15 Nov 16 Nov 19 Nov 20 Nov 21 Nov 22 Nov 23 Nov 26 Nov 27 Nov 29 Nov
5596.75
5624.40
5583.05
5614.85
5714
5656
5630
5688
5609.85
5649.75
5601.95
5645.05
5683
5623
5597
5657
5696.35
5711.30
5682.55
5697.70
5655
5602
5576
5630
5693.05
5709.20
5679.50
5702.25
5689
5635
5610
5663
5694.10
5730.80
5693.65
5724.40
5705
5648
5622
5679
5718.60
5777.30
5711.40
5760.10
5722
5655
5630
5696
5709.00
5744.50
5693.95
5738.75
5759
5698
5672
5733
5731.10
5751.70
5677.75
5686.35
5772
5702
5676
5745
5688.45
5718.90
5665.75
5686.80
5764
5702
5676
5738
5689.70
5698.25
5660.35
5661.25
5753
5696
5670
5727
5650.35
5651.65
5603.55
5631.00
5755
5694
5668
5729
5624.80
5650.15
5559.80
5574.05
5737
5662
5636
5711
5577.30
5592.75
5549.25
5571.40
5699
5640
5615
5673
5604.80
5613.70
5548.35
5571.55
5665
5599
5574
5639
5582.50
5620.20
5561.40
5614.80
5643
5579
5554
5617
5628.60
5643.35
5608.00
5627.75
5630
5575
5550
5605
5635.45
5637.75
5593.55
5626.60
5650
5592
5566
5625
5648.65
5649.20
5623.45
5635.90
5646
5594
5568
5621
5658.50
5733.20
5658.00
5727.45
5646
5577
5552
5621
5736.70
5833.50
5736.10
5825.00
5667
5591
5566
5642
Notice that the trend turns bearish on the day immediately after the expiry of October contracts on 26th October just below 5664 near the close of this trading day. So having acquired honing trading skills by now, you would sell the Nifty futures at the going price of 5702.
To create a contrary position, you should consider selling 5600 PE at a price of 53 points. (May I remind you here to access the achieves at nseindia.com and if you notice any discrepancy, write to me immediately from the ‘contact me’ page at niftytracker.com). This strike has a pretty small IV. Take a little time calculating this using your Options Pricing model worksheet. Upon writing this put option, keep in mind that the maximum profit from this strategy comes to: MP = 5702 – 5600 + 53 = 155. And the reversal point on the upside happens to be: RV = 5702 – 53 = 5755. This may seem close rather close but with the past few months’ experience you are actually hoping for a reversal so that the maximum profit potential may be revised upwards for you on the next leg of action. As you watch the flow of Nifty, alert to the possibility of the market going above 5755, you notice that on 7 th November, the trend turns distinctly bullish at the index spot value of 5760 as the closing price for the day. As you square off your short futures at a price of 5793, taking a loss of 91 points, you also contemplate selling call options of the nearer strike of 5800, which is trading at 65 points or selling call options of strike 5900, trading at 28 points. This phase of trading raises an interesting question of choosing the right strike price to be sold. The choice is between selling the 5900 strike and the 5800 strike, and can easily be answered by calculating the breakeven and reversal points. Now, the maximum profit at the 5900 level is given by: MP = (5900-5793 + 2*28 + 53 – 91)
= 125. The breakeven or exit point for the strike 5900 is given as: BEu = 5900+ 125 = 6025. The reversal point on the downside is calculated as: BEd = RV = 5900 – 125 = 5775. This is troubling because the spot value of Nifty is already 5760 which is lower than the reversal point. Obviously then, the 5900 strike is not a valid choice. Switching to the 5800 strike, you decide to write the call options here for a premium of 65 points. Now the maximum profit potential at 5800 level is seen as: MP = (5800 -5793 + 2*65 + 53 – 91) = 99. Oops! This is less than the initial maximum profit potential of 155. This fact alone should warn you to be very careful on the next leg of action, should the Nifty decide to reverse directions once more. Let’s calculate the loss you would incur if you decided to chicken out now and square off your positions today on 7 th November. You already have a loss of 91 points on the short futures but the short put options are making a profit of 37 points since they are quoted at 16 points at this time. So your net loss if you close out both positions comes to about (9137) which is 54 points. But let’s go on to execute the reversal leg, if only to learn how the scenario orks out.
The maximum profit now stands at 99 points if Nifty closes at 5800 on the expiry date. If Nifty continues to rise beyond 5800, the exit point on the upside would be 5899 which would return a null profit if the Nifty closed at this value on the expiry date. On the downside, the reversal point would be 5701. Now, since you have already taken two actions in this month, you allow yourself just one more action on the next reversal, at the calculated reversal point of 5701, or at the maximum profit level of 5800, and that is to square off all your positions, take your profits or losses to get out of the market. A reversal is indeed seen on the charts on 9 th November when the Nifty is seen closing at 5686, below the reversal point of 5701. You can now initiate the third leg of your CPR futures and options strategy by selling the long futures at the available price of 5723, taking another loss of (5723-5793) which is 70 points. As you begin to short the index futures according to your CPR trading plan, you might pause to give a thought to the contrary action to go along with the strategy. You may sell two lots of put options as you always do but that ould create three lots of put options of strike 5600 in your portfolio. And if the Nifty drops to a level much below this strike, you may have to face a huge loss with these three lots. The contrary action for the short futures is therefore the writing of two put options of strike 5600 at a price of 22 units. You now have short futures of one lot at 5723, one lot of 5600 PE sold at a price of 53 points, two lots of 5600 PE sold at the price of 22 points each, and two lots of 5800 CE at a price of 65 points each. Now, the maximum profit potential for this combination at the expiry level of 5600 is calculated as: MP = (5723-5600 + 1*53 + 2*22 + 2*65 – 91 -70)
= 189. Great! Now the maximum profit potential has increased to 189 from the original potential of 155 points. The breakeven or exit point on the downside is estimated at: BEd = 5600 – 189 = 5411. And the breakeven or exit point on the upside is seen as: BEu = 5600 + 189 = 5789. The breakeven point on the upside is no longer called the reversal point since the fourth leg of your action must only be to exit all positions. All goes well with the daily closing Nifty not breaching these levels. Now the exit plan comes into force from the 18th November since only 12 days are left to expiry which falls on 29 th November. The 13 days criterion includes the trading holidays of Saturday and Sunday so 18th November is the day from when you would be looking to get out of all positions should you see the Nifty around the value of 5600, which is where you would reap most of the MP attainable. The Delta could be nearly more than 0.8 during these days and would only increase as the expiry day approaches. Indeed, you do see this level, and let’s say that on 23 rd November, when you have the Nifty touching 5600 during the day, you decide to promptly square off all positions. These are the values for the various derivatives at which you would exit : Futures, F4 = 5608 PE 5600, PP = 22 CE 5800, CP = 1.5 You can now calculate that the realized profit from this squaring off action as
below: RP = (F3 – F4 + 1*PP1 + 2*PP2 + 2*CP1 – 3*PP – 2*CP + L1 + L2) = (5723 – 5608 + 1*53 + 2* 22 +2*65 – 3*22 – 2*1.5 – 91 - 70) = 112. The exiting of all positions on this day when you spotted the Nifty value around 5600 has not only resulted in a rather decent profit but just saved you from a huge loss. The exit rule on the fourth leg of action is the only one that needs your attention on the underlying asset’s spot price throughout the day. Had you remained complacent and waited for the expiry day, you would have churned up quite a loss as shown below: For the spot value of 5825 at the close of the expiry day, Realized Loss = (5723 – 5825 + 1* 53 + 2*22 + 2*65 – 3*0 – 2*25 – 91 – 70) = - 86 Could you have foreseen this setback on the expiry day? Looking back with the advantage of hindsight, you may need to appreciate that the market can outwit the smartest strategy. The only means to circumvent this peculiar tendency of the market is to humbly acknowledge the fact and take care to square off all positions during the last 12 days of trading (less than 13) prior to the expiry date when you see the maximum profit potential level being touched. Now, armed with this fresh insight to exit positions if the market offers you a chance to book profits at the maximum profit potential value during the last 12 trading days, you go forth with greater confidence into the next months. By the way, the trend following plan on the Heikin Ashi charts reveals that you could have made a profit of 191 points from four trades conducted during this period. The MHAF trading plan wins again quite comfortably this month.
The Month of December – 2012 The bullish trend that begun on 27th November continues well into December, until finally on the 13 th December, you notice a clearly distinct bearish trend with the Nifty closing at 5851 below the sell trigger of 5860. Acting swiftly, you short the index futures at a price of 5877, simultaneously selling the put options of strike 5800 which gets 31 points in your trading account. The maximum profit that can be had from this covered put strategy can be seen to be 108 and the reversal point happens to be 5908 on the upside. The 19th of December does see the Nifty closing well above this reversal point at 5930, so you hastily square off the short futures at the going price of 5944 taking a loss of 67 points. The expiry date for the December contracts is scheduled for 27 th December, hich is just 8 days away. This factor alone necessitates that you close out all positions as there won’t be enough premiums available in order to make the transition to a bullish phase worthwhile. But just as an exercise for polishing your trading skills, do let’s see how the next triggers for reversals and the maximum profit potential work out. If you reversed your short position in Nifty futures, you would be buying two lots of the futures, one for squaring off the earlier shorts, taking a loss of 67 points, and the next for creating a long position. This would imply that you sell two lots of call options for the nearest strike of 6000 to act out the contrary requirements of your trading strategy. The 6000 CE are trading at a price of 23 units, thus as you sell these options you receive 46 points in your account. Now, the maximum profit potential at the Nifty spot value of 6000 can be seen as:
MP = (6000 – 5944 + 1*31 + 2*23 – 67) = 66 The breakeven point on the upside is estimated at: BEu = 6000 +66 = 6066 While the reversal point on the downside is at: RV = 6000 -66 = 5934. This is very near the futures price value now, while the Nifty spot is already below this value at 5930 and so the situation is screaming out an ABORT arning.
Therefore, you decide to keep out of the market by squaring off your initial positions, taking a loss of 67 on the short futures but taking a profit of 23 points on the short puts which you have bought back for 8 units. This month has penalized you with a loss of 44 points. The MHAF trading plan on the other hand gives a loss of 65 points over the same period, and if you continue to trade the rest of the month with this trading, a total loss of 136 ensues. Keeping out of trading the rest of the month with your CPR and exit plan strategy has worked out fine for you after all.
The Month of January – 2013 A somewhat indecisive market since the expiry of last contracts finally turns bullish at the start of this month on the 1st day of the year, with Nifty closing at 5951 which is well above the buy trigger of 5921 on the MHAF worksheet. You could buy the Nifty futures at a hefty premium price at 6007, and taking the nearest call strike from Nifty spot of 5951 at 6000, also decide to sell these call options at a price of 91 units.
This should give a maximum profit of 84 points and a comfortable reversal point on the downside at 5916, while secretly hoping that perhaps the Nifty ould reverse trend just once so that the maximum profit potential could move up a bit. Over the next many days, you watch as the Nifty moves up and away and back to its beginning levels, keeping alert to the possibility of Nifty breaching 5916 level which is never reached. The Nifty keeps in a narrow range and closes finally at 6035, giving you the promised maximum net profit of 84 points. Of course, with the lesson learnt from the month of November 2012, you could have booked almost 90 percent of this profit during the last 8 trading days of the month when the Nifty was hovering well around the maximum profit target of 6091. Let this be an integral part of your trading style, so that the pitfalls of the expiry day can be circumvented. As you compare this profit to the simple MHAF chart trading, you note that you could have taken a loss of 82 points. So far, the CPR F&O strategy is keeping you on the right side of the markets.
The Month of February – 2013 The following month begins with a clear bearish trend right on the first day, ith the index closing at 5999 below the sell trigger of 6013. Quite mechanically now, you create a covered put combination by selling the Nifty futures at a price of 6037 and simultaneously selling the put options of strike 5900, the one naturally lower to the Nifty spot value of 6013, at a price of 35 units. This suggests a maximum profit potential of 172 points on the downside and a reversal point on the upside at 6072 which is rather close, but hey! You do hope the market won’t remain where it is and give you a chance to make greater profit by changing course.
Regardless of your expectations, or perhaps in line with your expectations, the market never shows you the reversal point but continues moving southwards to close the month at 5693 on the last day of the month which as also the expiry day. Again, in line with your lesson of November-2012, you could have squared off your position during any of the last 8 trading days of the month, getting about 90 percent of the stipulated profits since the index was trading below the profit target price of 5865 ( given by the PS minus the premium). The month delivered its promised profits of 172 points to you without any hassles. And funnily enough, if you had followed the MHAF trend plan, you ould have made exactly the same amount of money! Mice and men come out even this time.
The Month of March – 2013 The long bearish trend from February finally ended on 5 th March, with the Nifty closing at 5784, comfortably above the buy trigger of 5768. This bullish scenario compelled you to buy the index futures at a price of 5802 and to simultaneously sell the call options of strike 5900 at a price of 31 units. The combination promises a maximum profit potential of 129 points but cautions on the downside reversal point at 5771 Nifty spot. The Nifty does indeed close below this reversal point at 5746 on 19 th March, so you proceed to square off the long futures at a price of 5753, taking a loss of 49 points. Squaring off the call options at this time would entail paying back 13 units hich would give a profit of 18 units, thus reducing the net loss to 31 points. Now, less than 13 days are left to expiry, so you would not want to take the next step to go to Act II. But just as an exercise, let’s see what happens if you
do. You are a bit hesitant about taking the next let of your strategy because just 9 days are left to the expiry of the contracts for this month which falls on 28 th March, and so you must reach your maximum profit potential within the next few trading days. Taking a peep at the put options price, you find that the 5700 strike puts are still trading at 42 units, so you might still get 84 units in your account if you go ahead. Well, then you create a short position in futures at 5753, and sell two lots of 5700 PE at a price of 42 each. Calculating the reversal triggers and the maximum profit potential at Nifty spot value of 5700 gives the following figures: Maximum Profit at Nifty spot 5700 = 119, Reversal point on the upside = 5819, and Breakeven or exit point on the downside = 5581. There is a bit of a hesitation here as the profit potential is slightly lower than the one promised at the start of the month, but since the reversal points are a ay off, you can go along with the strategy with the determination to get out as soon as the spot value of 5700 is seen during the last 8 trading days of the contracts’ lives. As it happens, the spot value of 5700 that promises the maximum profit was hit the next day as the Nifty closed around 5700 on 20 th March. Remembering the training from the month of November, you decide to exit all positions since now only 8 days are left to expiry. The exit values for your positions are shown below, as seen from the historical archives of nseindia.com: Futures, F3 = 5720 5800 CE, CP = 7 5700 PE, PP = 48.
The realized profit can now be calculated as below: RP = (F2-F3 + 1*CP1 + 2*PP1 – 1*CP – 2*PP + L1) = (5753-5720 + 31 + 2*42 – 7 – 2*48 – 49) = - 4. Well, that is actually a loss of 4 points, slightly less than the 31 point you ould have booked if you had decided not to go through the trades on 19 th March, but a loss nevertheless. Now, how about checking to see if you had not squared off on 20 th March but decided to see the end on 28 th March? For this purpose in comparing the results of the CPR F&O strategy, we shall be looking out to square off only when the closing Nifty violates the reversal point. This never happens and at the close of the expiry day, the Nifty stands at 5682. You can then calculate that this closing results in a profit of 101 points for this month. Squaring off about prior to this closing would have resulted in a slightly lesser profit, but profits nonetheless. While this action results in a net profit of 106 points, but with an earlier loss of 49 points on the long futures from the first leg, the final profit comes to 57 points for this month. For our comparative study, we shall consider the actual loss accrued of 31 points on 19th March. Note that the MHAF charting pattern returned a profit of 91 points during this month.
The Second Half Results Month
Strategy
October - 2012
Covered Puts Covered Puts followed by partly Covered Calls and partly Covered Puts again Covered Puts Covered Calls Covered Puts Covered Calls followed by Covered Puts
November - 2012 December -2012 January – 2013 February - 2013 March - 2013
Sum of Profit/Loss
Profit/Loss from Strategy 35
Profit/Loss from MHAF -168
112
191
-44 84 172
-65 -82 172
-31
91
328
139
The second half of the year has resulted in much smaller profits in both the categories. However, in spite of the some losses in two of the months, the CPR F&O strategy has fared much better over the long run. For the 12-month period, we have the net profit from the F&O strategy at 1216 and the net profit from trend charting pattern at 789. It was only during the months of November and March that you squared off all positions prior to the expiry day. Had you waited to see the expiry day closings, you would have made slightly lower profit of 262 points for this second half year trading, so squaring off during the last 12 days of the contracts’ life seems a good idea after all. And if you had opted to square off whenever you received about 80 percent of the maximum profits available for the rest of the 10 months, you would have made 1018 for this 12-month period which is still better than the trend following plan. Note that we have so far completely ignored relevant delta exits but still arrived at satisfactory results. Perhaps taking care to make sure to exit at the right delta would have yielded even better profits with the improvisation. With these results and the trading strategy firmly established, you can now go
ahead and test the CPR on other indices, currencies, stocks or commodities.
If it doesn’t matter who wins or loses, then why do they keep score? – Vince Lombardi.
6. In Conclusion: Outsmarting Mice The mice may win the game by observing a pattern. They spot greens or reds and bet on just one outcome to their advantage by noticing that greens tend to appear more than the reds. We can do that too. And we can win further by not just observing and acknowledging patterns, but by inventing and playing complex hedging tools like futures and options. We can play the game to our advantage by devious means of planning strategies to transform a simple game of: heads I win but tails I lose, to a complex game of strategies that lead to a ‘Nash Equilibrium’. The movie “ A eautiful Mind ” (2001), made popular this brilliant mathematical approach of John Nash, a Nobel Laureate in Economics. With our complex financial tools, we can play the game to everyone’s advantage approaching the Nash Equilibrium position where economic good happens for all, and market transactions are no longer ‘zero-sum’ games of heads I win to tails you win. Various strategies played out by numerous market players make winning the game all the more easier for everyone. So there are even more complicated strategies of calendar spreads involving derivatives of different months and simpler ones of options spreads and covered calls or puts, or protective puts and calls. There are also the fancy named butterflies, straddles, collar and condors, all played out in our markets but ultimately approaching the Nash equilibrium together in unison. For more complex strategies, even more mathematics may be involved along ith its associated what-if scenarios. Unless you have this gift of abstract mathematical acumen, it would be best to stick with a simple strategy that you can easily work out and that becomes second nature to you. But remember, no strategy is perfect, at least not perfect enough to yield
maximum profits every time. With the CPR F & O strategy explained here and its simple calculations, you have a method for playing out the game month by month. You have seen that as soon as you initiate trades, you immediately have your what-if scenarios for reversals and exits worked out for the rest of the month. A great thing about the strategy is that you can plan your actions only near the closing bell for the day, except for the day when you have to exit at the maximum profit potential level during the last days of the contracts’ lives. Intra-day fluctuations no longer bother you, the optimism bias is done away and you also throw the two emotions of fear and greed out the window. The strategy can also be applied to stocks, currencies or commodity derivatives, as well other indices where futures and options are actively traded. It is just a question of how many instruments you can handle every month. I would suggest no more than five, comprised of a couple of indices and your favorite stocks or currencies if these are very actively traded on your exchange. As a Taoist would say: Less is More. Please feel free to interact with me through my website at niftytracker.com and remember to sign up for receiving updates to the book and an occasional newsletter there. There may yet be some oversights in text or formulae or figures, even though I have gone through the book’s figures many times over. Do point these out when you find them by contacting me through my ebsite. Since your views are very important to authors and their book, please visit the book page again and scroll down to the ‘Customer review’ area to write about what you liked and choose your star rating for the book. Happy Trading!
Other books by Avinash Khilnani: The Modified Heikin Ashi Fibonacci Trading System
The book guides the readers in creating a personalized trading system that allows for the laws of large numbers and probabilities in an unpredictable place to work in their favor by keeping their trading actions in sync with unpredictable trends of market price of indices, stocks or currencies. That goal is achieved by modifying the standard Heikin Ashi chart quite a bit and using the Fibonacci ratios to create triggers for entry and exit points hile instructing the readers in detail to create their own spreadsheet and charts, assuming the readers have some working knowledge of a spreadsheet.
The Fibonacci Dictated Trading Script A stage play is set for playing index futures against index options, demonstrated as a real world example of the Dow E-mini futures and the DJX options. The reader is guided to write a trading script for the stage before the play actually begins as a simple Excel worksheet. Fibonacci ratios and numbers dictate the writing of the script and extensive use of the BlackScholes option pricing model ensures that optimum exit point, reversal points, profit or loss, rolling up or rolling down figures are calculated well in advance of the actual play.
