OTM Options, a best trade in directional dilemma

F&O Market

Shubham Agarwal

Options in themselves have a lot of flexibility as far as profit and loss is concerned. We all know that Options have capacity to restrict losses yet keep the profits unrestricted for our trades. This feature of options helps us a lot when the market is indecisive.

What better time to discuss this than now. As we see Nifty struggling around 19,500, questions arise in the minds about sustainability of the trend. At the same time, we cannot rule out past several rallies that have taken place after a brief pause.

Here is where Option come into play. Here we do not get punished if we are wrong, yet we hit a jackpot if there is a breakout or reversal. One of the things that hurts us though is that we cannot rule out reduction in premium due to time value.

Now, most of us deal with this by closing the trade after a day or so if there is no movement. However, in a prolonged period of pause where no big move happens it does hurt. OTM (Out of the Money) options can help here.

What are OTM options?

OTM Options are options with Strike Prices below current market price for Put Options (Option to Sell) and above the Call Options (Option to Buy). If that strike Put/Call option expires today, we will be selling lower / buying higher than current market price. Since if acted upon the option will not make any money hence Higher Strike Calls and Lower Strike Puts (compared to current market price) are called Out of The Money or OTM Options.

How Do They Help?

1. Lower Investment:

OTM Options will be capable of making money only if the favourable move comes. This dependency of the move makes them less attractive to buy. Hence, they are cheaper. So, the first help that we have is that it makes our investments smaller in a trade.

Remember, these could very well be times when we may have to make too many rounds up and down before a breakout or reversal takes place. With same amount of money OTM Options give us more opportunities to trade.

2. Higher ROI Vs Profit:

No doubt the more expensive options than OTMs will make more money. But, when we are at a make or break we are looking at a big move. Remember the Profits made by OTM options in absolute terms will be lower than other options but if a big move takes place the ROI will be much better than the other Options.

Example

Stock @ 100

100 Call (Regular Option) @ 3

102.5 Call (Higher Call = OTM) @ 2

Stock Moves to 110

100 Call (Regular Option) @ 10.4

102.5 Call (Higher Call = OTM) @ 8.3

Profit

For 100 Call = 10.4 – 3 = 7.4 = 246%

For 102.5 Call = 8.3 – 2 = 6.3 = 315%

Thus, OTM Options can get you to trade better in case we have directional dilemma.