Buying Options — Trade Selection Process Explained

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On this blog the option buying journey has completed 13 months.

In this period, 173 options contracts were bought. 62 of them paid out some profit while 111 gave a loss. The success rate is 35.8% which is really good in option buying. Conventional market wisdom is that about 80% of options expire worthless. In our case, that percentage is below 65%.

With this success rate, the trades could generate a profit of Rs. 666708.

This profit could be made from a trading capital of just Rs. 200000 without risking more than Rs. 100000 at any time during these 13 months.

The success is mainly attributable to the Trading Selection Process and then waiting with the right trades.

There is regular demand from the readers to explain the selection process completely.

I have done it earlier and am doing it again for the benefit of new readers.

Some people have advised me about not sharing my trading method. They think that the method will not work if more people start following it. My views are different. Not many people follow good advice. Stock market is not different from life.

All of us get good advice like avoiding drinking, smoking, telling lies etc. We get advice about exercising and going for a walk for keeping good health. All of these are proven ways for staying healthy but there are more people who ignore these things than who follow.

Regarding trading advice, this is what ace trader Richard Dennis said:

“I don’t think trading strategies are as vulnerable to not working if people know about them, as most traders believe. If what you are doing is right, it will work even if people have a general idea about it. I always say you could publish rules in a newspaper and no one would follow them. The key is consistency and discipline.”

So, here I am publishing the rules in the newspaper. To follow or not is the choice of the readers.

Step 1 :

Go to this page on NSE website.

https://www.nseindia.com/live_market/dynaContent/live_watch/equities_stock_watch.htm

You see this:

This page shows us how much the NIFTY gained over 365 days and 30 days period and all the details for the 50 stocks in NIFTY 50.

Step 2 :

Click at the extreme right column – 30 day % change.

This will sort out the stocks with biggest loser on top.

Now it looks like this.

This shows us that YESBANK has lost 15.02 % in the 30 day period while NIFTY has gained 3.24%. DRREDDY has lost 12.32% in the same period.

The stocks which have performed poorly in comparison with NIFTY will be considered for a PUT trade.

Step 3 :

As an example, let us click on DRREDDY in the first column.

We get this screen.

It shows the stock price movement for the day.

We click on Historical Data link and select 7 Day period from the drop down menu.

The 7 day data shows the details for 4 days. It does not matter whether it is 4 days or 6 days. We are looking at whatever this site gives us in the simplest way. Too much research does not add value to our trades.

This screen tells us that the stock continues in the downward direction as it has moved from Rs. 2724 to rs. 2580. We look at the general direction only and not the daily ups and downs.

This confirms that DRREDDY is a weak stock over the 30 day and 7 day period both.

We also see that the stock has made a low of rs. 2400 just 3 days ago and the 52 week low is at Rs. 1872.95 made in February 2019.

Step 4 :

The first 3 steps should take less than 3 minutes.

In the previous screen there a link to Option Chain on top right.

We click this link to go to Option Chain of DRREDDY.

It looks like this:

CALLS are on the left side and PUTS on the right. We are looking at the PUTS.

We look at the Implied Volatility ( IV ) of the options for the Strike Price near to the current price.

We see that for PUT 2600 it is 31.46.

This number is dynamic and we will not get bogged down by too much detailing and analysis. We take a trade if the IV is between 30-50. We make exceptions sometime and go for up to 60 on the high side and 25 on the lower side.

DRREDDY qualifies on IV criteria.

Now about selecting a strike price.

With IV on the not very high side, we look for an Out of Money PUT about 5% away from the current price.

That will be nearly 2450.

Strikes are available for Rs. 100 gaps, so we go for PUT 2500.

PUT 2500 was traded at Rs. 40.00 on Friday. With lot size of 250, it will cost us Rs. 10000 which is our maximum risk in this trade.

The selection process is now complete.

Risk reward of this trade :

The trade is based on the very simple fact that DRREDDY is showing considerable weakness in a strong market. There must be a reason for this and that reason will not vanish suddenly. There is a possibility ( good possibility ) for the down trend to continue for the same reasons.

If the stock just about moves to the recent low of Rs. 2400 by expiry, the PUT 2500 will be valued at Rs. 100. If the stock moves lower than that, our gains become better. We wait for the gains which the market gives to us secure in the knowledge that our loss can not be more than Rs. 10000.

This was the 4 Step Method for deciding an Option Buying Trade.

Let us get back to the Step 2 again.

Click on the extreme right column of 30 day chg % 

Now we get gainers on top.

Step 2 :

We see this screen.

TITAN is the top gainer in the 30 day period followed by BAJFINANCE and ADANIPORTS.

Looking for a CALL trade in TITAN.

Steps 3 and 4 have already been explained. I am going to Option Chain of TITAN straightaway.

Look at the Implied Volatility ( IV ) column.

It is nearly 20. Nowhere near the 30 level which is our minimum requirement. We could make an exception if it was around 25, even that is not seen.

Therefore, TITAN CALL is not a trade for me at this stage.

A CALL in TITAN may work out for all we know but our method does not suggest this trade at present.

For other trades, I would expect the readers to work out for themselves.

Step 2 Again :

In the first screen shown in this page, NIFTY 50 is the default drop down. 

From the same menu one can select NIFTY NEXT 50 and NIFTY MIDCAP 50 and find another list of 50 stocks each.

There is a FO Stocks list too which lists all the F&O stocks.

Rest of the process is same.

Another Point :

It is part of the Step 4.

We take a trade if at least 100 contracts were traded in the same strike on previous day. We do not venture into stocks where option volumes are like 3, 10, 17 etc.

Good volumes give right prices.

Performance of this method :

This method fails more than 60% of the time. Sometime it has given only 1 Right trade out of 10.

It can fail badly at times.

But over a period of 13 months, it has been successful 35% times i.e. in 62 trades out of 173.

These trades generated a profit of Rs. 666708 on a risk capital of just Rs. 200000 in these 13 months.

Details can be read here:

http://optionsnext.com/blog/the-options-journey-one-year-may-2018-to-april-2019-a-review/

Summary :

About 80% Options expire worthless.

A method which does better than that ( 35% success ) is a good method.

The key to profitability is the belief in the method, patience and discipline. The results speak for themselves.

Keep working out your trades based on the method, keep the belief and money will be yours to keep.

Enjoy your Sunday.

 

 

 

 

 

 

 

16 Comments

  • Azar Shaikh

    Sir
    Person having low capital and got 2 to 3 consecutive loosing month.He will be running out of capital.If he decide to less trade then probably of winning down drastically.How to balance this?

  • Satish Kumar

    thanks a lot sir for such wonderful and simple explaination. One of the great thing which we learn from you is the patience and exit time of trade with huge profit. This really helped me a lot from early exit in trade.

    DRREDDY weakness is clear in the last week when there was huge long spike on 4th June. I took DRREDDY 2500PE @ 26.35. It went upto 57.5 on 7th June. now it is at 40.

    Sir, how you see Biocoin 1:1 bonus of 12th June. Is it impact our earlier selected trade ?

  • Ravikumar

    No need to search for options techniques anymore. No one can describe it more simple. This is enough . HONESTY is the hallmark of Pramod sir.

  • Tharik

    Dear Sir,
    It would be great if we could get the number for the average money made in winning trades and the average money lost in losing trades.

    Thanks in advance.

  • NARAYANAN

    Your method of options buying…awesome. For me it is a Bible for options buying. Hats off to you Pramod Sir. Keep us posted with such analysis in future also. Keep it up
    Thanks and Warm Regards
    NARAYANAN

  • Sudip

    Frankly speaking, i think your record is notvso good, 33% is really low as per profitability is concerned, i think you keep on and on which really hurts on profitability, also, i feel you enter a bit late, in fact a lot late, where any stock is looking to rebound.

    • Anand Kumar

      Hi Sudip,

      I think we sometimes have this feeling, because most of the times, we remember the trades that went bad. The trades went completely in opposite direction because it rebounded.

      But we generally don’t remember the ones which went in our direction in great amounts.

      So I think it’s better if we go with actual numbers than with biased and short term memory.

      Even with 35% success rate, this method has generated now than 6L profit in a year. Doesn’t that speak for itself?

  • Manas Kumar

    Thank you Sir, I was searching for this once in the earlier blogs since last few days.
    What I also need to know is the bullish or bearish nature of markets in a given month because that also decides the selection of calls/puts.

  • Vishal

    Wow. My all the blessings from Pune to you Sir.
    Honestly speaking I have lost 2 lakhs during the process of following your blogs. The misfortune was mainly trying to time the market and going against your rules. I entered the trades as per your suggestion but manipulated as per my greed + hope + fear. I’ve no regrets of loss. I consider this loss as tution fee to Mr. Market.
    Thanks again and wish you a healthy life.
    -Vishal

  • Akash Bari

    Very well explained. but one point is missing is when to exit and take profits. or continue to carry these trades until expiry.

  • OP Mathew

    Suppose I took 2 positions today and on next trading day it is showing profit of 30k and 20k.

    Should I book profit?

    If I wait till end of day, positions lose value and end at 10k and 10k.

    Tomorrow it may or may not rise.

    How would you approach this scenario.

    • admin

      Apparently what you said makes sense. But then you miss out on the big pay off when it happens.

      The way is to book the profit and move to higher or lower strike ( in case of call or put respectively) so that more profit comes in if the trend continues.

      Cheers.

  • Vijay

    Dear Sir,
    I have read many option books and done trading for 3-4 years but this is the simplest strategy I have found. How about we keep booking profit at regular intervals and go for OTM strikes while simultaneously booking profit in successful trades. Whats the problem in such strategy?
    Thank you.

  • MS Advani

    I ‘m an Options Seller for more than 5 years. So the one taking the opposite position.

    The success rate which you are talking about i.e. 35.8% will likely keep decreasing as the years pass by and by Year 5, it is likely to be between 6-8%, no matter how good your stock selection process is.

    I know your stock selection process is good and it will turn out right ultimately but time is always likely to run out before the stock movement works in your favour.

    Atleast that’s my experience as an options seller.I started with very low success rate and but as the years went by the success rate started inching up slowly.

    Best of luck with your options buying journey.I really do hope that you make it and prove that this method works in the long term. In the meantime, I will continue with options selling.

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