Option buy using Algo

Are you a Banknifty Option Buyer

If you are Banknifty option buyer, and looking for a guide how to become a profitable Algo trader. Then this content is for you.

Option trading is very lucrative. Specially for the retail traders due to its very low fund requirement. If we want to Buy Banknifty Future we need to pay Rs. 1.3L (Approximately) as margin. Whereas Banknifty ATM (At The Money)  Call or Put option can be bought with as low as 10K-20K fund (That depends on volatility). 

Due to options low fund requirement and potential to generate similar return as Futures, retail traders with low fund always get attracted towards Option buying. 

The variance is the DELTA which is medium in ATM (At The Money) high for ITM (In The Money) option strike prices and low for OTM (Out of The Money) option strike prices. 

How to choose the correct Option Strikeprice

For a option buyer using algo trading, selecting of option strike price is very important to calculate the profitability. That is because of  DELTA. Delta is the parameter which  differentiates the price between the underlying’s Future price movement and all its option premium prices movement.

DELTA Range:

Generally Delta ranges between 0.5 to -0.5 for ATM (At The Money) option strike prices. Delta is 0.5 to 1 for ITM (In The Money) Call strike prices and Delta ranges from 0.5 to 0.1 for OTM (Out of The Money) Call Options. For Put options its negative value as Put premium increases with fall of the underlying asset. 

As Delta plays the major role for generating different profit points. It becomes important to understand which option strike price shall we choose for our Option buy and what return can we expect from that selection.  

Use of Delta to maximize Profit:

To get maximum price movement benefit, we shall choose In the Money or ITM option strike price. Provided that permits our budget. Where Delta value is the high and very near to 1 for a Call option. The benefit will be, we shall get the 60-90% price action benefit. 

We can also opt for At the money or ATM option strike price. If we want to play safe and want to get good return on option buy with moderate investment. Where by each points of Banknifty’s movement we can get 40-60% price movement benefit.

If we do not have budget to buy ATM call options, then we should buy OTM options. Based on budget try to buy near OTM to get the maximum price action benefit of Banknifty. If we go Far Out of the money, then the Delta value shall keep reducing. In such situation we tend to get very little benefit from Bankniftys price movement. 

Please remember far OTM (out of the money) option strike prices are good for option shorters and ITM (in the money) option strike prices are good for option buyers. 

When to Buy Call and when to buy Put

We shall buy Call option if we anticipate Banknifty shall move up and we shall buy PUT option if we anticipate Banknifty to go down. 

Here comes the question of how to understand if Banknifty shall move up or Down. To do that you need to predict Banknifty’s direction. That can be achieved if you know  technical analysis.   

If you are a new trader and new to Stock market, then it is advisable to first learn the basics. Learn as much as you can before taking the first trade of your own. Learning in stock market is a continue process. You can also take help from an expert. Experts are those individuals or machines (Algo Bots), who are trading in the market for some long time. They have domain knowledge and understanding to identify the momentum. 

Advisors or Algo bots can also go wrong, but even if they go wrong they exit from the position early by minimizing the risk. Here comes the concept of Stop loss. If you are trading in option buying (let us restrict us for option buy) then you must have defined stop loss.  in case  your prediction goes wrong you should exit from your trade the moment your SL hits. 

Why Stop Loss is so important

Stop loss is the best action for a trader to take. Once you become a master of exiting at Stoploss, you have learned the skill of Trading in Stock market. 

Most of the traders looses money due to not exiting at SL or just not aware of when to exit if the trade goes wrong. 

Before you jump into trading, you need to first understand when to exit from your trade if your anticipation goes wrong. i.e. You have anticipated Banknifty shall move up and bought a Call option. But suddenly there is a change in direction and Banknifty takes a U turn and start moving down. In this situation  you should know at what price you shall exit from the trade to restrict you loss.

How Human Emotion can ruin our Trades:

Due to our emotional attachment with trade we tend to increase our losses. As loss increase, we generate a fear of making profit. The result of which we tend to exit with a very small profit thinking Banknifty might reverse.  We do this to save whatever profit we have made so far. While following this process, we increases our losses and reduce our profits. As a result our Loss keeps increasing high and profits remains less. In this approach we always fight to recover the loss and never come to a profitable zone.

How to become profitable in Option Buy

To become profitable in option buying we have to be very systematic. We have to follow a system which is proven to be profitable in past.  Please remember option buy always fight with Time decay, hence momentum is the ley in option buying. 

First we need to choose a system which has a good historical performance data. While choosing a system we need to keep n mind the following points. 

  • The system should have high Risk Vs Reward ratio
  • The system should be live in the market and generating profit in real trade

If you can either develop such system or get similar system from any service provider then our half the work is done. 

Next comes following the system regularly. As Option buy can not generate daily profit, we should not miss a single day trade. To avoid missing any single trading day we should setup our trading in a never go sleep mode. i.e. on cloud with 24×7 running commitment level. 

Calculate what can be your maximum risk per day, choose a strategy accordingly. Once your strategy selection is complete continue to trade on that Strategy. Do not change lot size and continue with the same trade setup.  Just consider you have kept the fund in a Stock or Mutual Fund and let that grow as its own. The more we keep changing our setup more vulnerable our P&L becomes.

If you are an Algo trader and making loss in Algo trading, then it may be due to the following reason.

  1. The strategy selected for Algo trade was not tested properly or is premature for live deployment.
  2. No consistency in trading on the same Algo bot
  3. There might be frequent change in multiplier or Lot size during profitable phase of the Bot
  4. There might be frequent change in multiplier during drawdown phase of the bot. 

In case either of the above points are true then this portion of the content is very important for you to follow. 

Please never ever reduce your multiplier after few drawdown. 

Every Strategy has its own phase of profits and losses. If we reduce the multiplier during drawdown phase then we reduce the probability of profits in lesser quantity. 


An example:

Suppose I have setup 2x Option Long bot (Ex. Option LongXL of DTMAlgo).

It was going ok during few months where the bot was giving me reasonable profits. But suddenly market becomes volatile and the bot starts hitting Stoplosses.

As the bot hits 3/4 Stop losses in last few trading sessions, as a Algo trader I felt panicked and to reduce further loss I thought it will be good to reduce my multiplier from 2X to 1X or might thought to pause trade for few days. Let us consider I changed the lot size from 2x to 1X.

So if I have lost in 2X in last 4 sessions, I have lost Rs. 3K x 2X in  4 trades =  24K. Now after changing the multiplier to 1X my probability to win is only 1X.

Consider the bot now hits target then I get 12K only not 24K (As 1x can generate maximum of 12K ), so even though the bot has recovered the loss (Lost 3Kx4 = 12K, then hit 1 target 12K so loss becomes -12K+12K = 0) , my trading account is still in a loss of Rs 12K.

As the bot has hit target I gain confidence on the bot and increased the lot size to 2X, but unfortunately again the bot hit SL and I lost 3K x 2 = 6K.

After this trade my loss is 12K+6K = 18K, but the bot is in a loss of only 3K (after last 6 trading sessions).  

By doing this we again fall under the same cycle of emotion and continue our journey of recovery and never reach the zone of profit. 

Please try to follow three golden rules:

  1. Continue to trade with same l0t size
  2. If you want to increase lot size as you have more fund to invest, do it after few drawdowns
  3. Do not reduce lot size during drawdown, but try to reduce if at all once you are in profit, so that during drawdown you can increase lot size.

If you are interested to start Algo trading, then you can contact us. Please feel free to share your side of story below. 

Surajit Chatterjee

Surajit Chatterjee

DTMAlgo, is a Fintech startup aim to offer fully automated institutional standard trading products for Retail Traders at affordable price.

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