Choose directional option writing over non-directional during election

Shubham Agarwal

Option Selling also known as Option Writing is one of the most liked trades due to being naturally successful. The very reason is Options lose a small portion of their value in premium as the time passes by.

Most of us start with Non-Directional Option writing. The meaning of this can be better explained with an example.

Nifty trading at 22,500.

Option Writing Strategy: Sell 22,000 Put & Sell 23,000 Call.

This is very simple and works with a basic expectation that Nifty would not expire above 23,000 or below 22,000. There are various models traders apply to ensure that they can arrive at the most efficient Call and Put strike. The Option premium should be enough to cover the margin paid for selling options while the strikes should be far enough that expiry does not happen beyond them.

This is a rather systematic trade and if done with proper risk management can give good money. However, with elections (or any big event for that matter) things get a bit different. The event creates Vega risk due to the rising path that IV (Implied Volatility) picks up.

IV: Expected Volatility by Option Traders back calculated by using market value of Option Premium (answer) in the Option Premium calculation formula. Vega: Rise in Option premium due to a 1% rise in Implied Volatility (Expected Volatility).

The problem is easy to understand. With the upcoming election, every passing day will bring new excitement and development. The unknown result of the event will keep raising the expectation of movement and the IV till the event is done.

With rising IV, the Vega will make the premium rise which otherwise would not have risen. The problem comes here when Time value related Profit in Option Writing is taken away by Vega increments in Premium.

Many Option Traders avoid Option Writing completely which is prudent step during the event. However, market will keep on posing opportunity during the event as well. So, instead of avoiding such Non-Directional Option writing, do Option wiring but the P-Directional style.

“P” we will understand a bit later. First the directional part. Instead of Selling both Call and Put, choose a side and stick to it. That is all that Directional Option Writing means. We all have been directional traders much before Options traded.

Directional Option Writing uses the same directional bias just the weapon of choice is different. So, for a bullish trade Sell a Put Option. For a Bearish trade Sell a Call Option. This is not an alternative to Futures trading or Option Buying but an alternative to Non-Directional Option Writing (Selling both Call & Put).

This will help in getting advantage of passing time as well as help from direction. Calls will reduce in premium if the underlying falls and Put will reduce if the underlying rises. These 2 factors (Time + Direction) will help fight the Vega-related losses in Option Writing better.

Now the “P”. We should not forget that event is still upcoming, so P is for Protection. For every Call/Put sold protect with Buying 2 steps Higher Strike Call/ Lower Strike Put. This will reduce the net premium earned but will make sure that we do not lose more than the difference between the bought and sold strike.