Saturday, 5 October 2019

How do we identify good option writing opportunities?

Following are some of the indicators that can be used to identify good options writing opportunities:
  1. Implied Volatility: This is one the Options Greeks, and is also one of the main components in Options Pricing. While there is no upper limit to which IV of any option contract can go, keeping a track on a daily basis can give a fair idea of the range in which the IV of an individual option contract trades. Whenever you see the IV breaking its upper range, you can Short the option. The success rate using this indicator is relatively high, as IV tends to relax after breaking out, giving a faster decay in options premium. This can also be used with Delta hedging strategy, to avoid naked options writing. To the best of my knowledge, historical IV is not available, or is available in “paid data” form by certain vendors. So, in order to make best use of this strategy, you may have to start tracking IVs of the contracts you wish to trade in, and then trade accordingly.
  2. Open Interest: Again, a very useful market indicator of ‘position buildup’ in all the F&O scrips. You can keep an eye on OI buildup of the underlying stock and/or indices, create a view of the market direction and sell options accordingly.
  3. Events: Personally, I have observed that options prices tend to go up before an event, like results sessions, or RBI bi-monthly policy or any major upcoming event (US Fed Policy, Brexit decision, Elections etc.) that may have a potential impact on the markets. Option prices rise sharply before the event and then right after the event, fall sharply. Essentially this happens because traders expect major volatility due to unexpected outcome of the events and they create more “LONGS” in the options, resulting in prices going up, temporarily. As soon as the events unfolds, positions are squared off, resulting in options prices falling sharply. This can be partly, viewed as an extension of point 1 shared above, but still is quite effective, if implemented properly.

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