Sharekhan Blog

3 Key Ways To Make Futures and Options Trading Profitable

  • Mar 9, 2024

However, the question "is option trading profitable?" is a common one, as the high-risk, high-reward nature also causes several traders to struggle to generate sustainable returns from derivatives trading.

In this comprehensive guide, we deep dive into 3 proven option trading strategies that can dramatically transform trading success:

Capture Directionality Through Bull Call Spreads

Bull call spreads allow traders to benefit from upward moves in stock prices while capping maximum losses from such positions. They provide an attractive and balanced risk-reward payoff profile.

Constructing a bull call spread involves:

  • Buying an in-the-money call option to gain from upside breakouts
  • Simultaneously selling an out-of-the-money call option at a higher strike to fund the purchased call's premium

For example, say stock ABC is currently trading at Rs 450. Now, to set up the spread:

  • Buy 1 standard lot of ABC 440 strike in-the-money call option costing Rs 25
  • Sell 1 standard lot of ABC 460 strike out-of-the-money call option receiving Rs 15 as premium

Here, the net debit to enter this spread is only Rs 10 per share (25 - 15).

Now, there can be two scenarios on expiry day:

  • If ABC is below 440 - The maximum loss incurred is restricted to the net debit amount paid, i.e., Rs 10 x lot size (loss is capped)
  • If ABC goes above 440 - Gains can be unlimited up to the short call strike of 460. If ABC moves above this too, gains are capped at Rs 20 per share ultimately (460 short call premium less 440 long call cost).

So this structure allows trading in the direction of the uptrend profitably while defining loss limits.

Traders can adjust spreads at opportune moments to stay invested in line with the evolving trend. Mastering the art of managing bull call spreads this way is key to consistently exploiting directional moves in the market. Designing an appropriate guaranteed profit option trading strategy with risk-reward in mind aids in sustaining profitable interest in line with market momentum using bull call spreads.

Generate Premium Income Through Short Condor Spreads

Selling options can generate regular income from high option premiums during rangebound, sideways moves in the stock price. One effective structure to employ for this purpose is the Short Iron Condor.

Constructing an iron condor involves a combination of the following:

  • Selling an out-of-the-money (OTM) call option at higher strike price
  • Selling an OTM put option at the lower strike price
  • Buying further OTM calls to cap "unlimited" upside risk if the market surges
  • Buying further OTM puts capping downside risk if the market crashes

This multi-leg structure allows pocketing net option premium income while the stock trades within the defined upper and lower boundaries.

For example, say Stock XYZ is at Rs 100 currently. To build an iron condor around this:

  • Sell 1 lot XYZ 120 strike OTM call at Rs 3 premium
  • Sell 1 lot XYZ 80 strike OTM put at Rs 2.5 premium
  • Buy 1 lot XYZ 130 strike further OTM call at Re 1 to cap upside risk
  • Buy 1 lot XYZ 70 strike further OTM put at Re 1 to cap downside risk

Here, the net credit for initiating this structure is Rs 3.5 per share. This income stays secure as long as XYZ remains between the 70-130 range till expiry. The short strikes sold can be rolled forward, if required, aligned with the stock's rangebound behaviour.

This demonstrates how iron condors allow traders to pocket premium income from sideways, rangebound drifts in the market, generating consistent option trading profits in the process.

Hedge Risks Prudently Using Spreads

While naked long options positions bring unlimited risk, carefully designed spreads can balance the risk-reward equation more efficiently. Let's understand two common hedging spread strategies:

Bull Call Spreads to Ride Uptrends

This involves:

  • Buying an in-the-money call option to benefit from upward breakouts
  • Selling an out-of-the-money call option at a higher strike to fund the purchased call premium

Bear Put Spreads to Protect Downsides

This is constructed by:

  • Buying an out-of-money put option to benefit if the market falls
  • Selling further out-of-money put options to fund the put purchase

For example, with ABC at 450 now:

  • Buy 430 strike put at Rs 120
  • Sell 410 put at Rs 80
  • Effective debt is reduced to Rs 40

So the long 430 put offers gains if ABC drops below 430, but the short 410 put caps it below 410.

Such combinations balance risk-reward attractively across market directions using appropriate spread positions.

The Bottom Line

In the pursuit of transforming options trading goals, a prudent approach lies in strategically employing three broad risk-optimizing techniques - design returns-focused directional spreads securing upside potential through longs while defined short positions check risk parameters; tactically generate income from rangebound markets by writing well-structured option combinations at various strikes. Determining the most profitable options strategy depends on one's market outlook and risk tolerance. Actively mitigate risks on existing assets using balanced spread positions, allowing participation alongside checkpoints.

Team Sharekhan
by Team Sharekhan

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