Previously in this column, we discussed several advantages of day trading derivatives compared with the underlying asset. This week, continuing this discussion, we show why options have a marginal edge over futures because of their asymmetric payoff.
Suppose you buy the next-week 17150 Nifty call, with the near-month futures contract at 17127. The option has a delta of 0.50. So, the option price will move approximately 0.50 point for every one-point move in Nifty futures price. You can use the delta to determine the number of options to buy for an equivalent position of the futures contract.
Typically, the delta of the option is compared with the delta of the underlying. Note that the delta of an underlying is always one, as it is the change in underlying price with respect to itself. Extending this argument, the delta of futures is one because we are using futures contract instead of the underlying. To create equivalent delta positions using options, you must buy two options (total delta of one) for one unit of futures. Translating this to permitted lot size, you must buy two contracts of 17150 calls to generate similar gains as one contract of Nifty futures for a given change in the Nifty index.
Now, suppose the Nifty futures index moves up 73 points to 17200 during a day. The 17150 call is likely to move 40 points for a gain 80 points (for two contracts) per unit of futures. What if Nifty futures increases to 17300, a gain of 173 points? The 17150 is likely to move 208 points.
What if Nifty futures declines 73 points to 17054? The 17150 call is likely to decline 70 points per unit of futures. And what if Nifty futures declines 173 points? The 17150 call is likely to decline 142 points per unit of futures. The above discussion shows that the at-the-money (ATM) option provides larger gains on the upside and lower losses on the downside, giving an edge over futures for intra-day trades. A caveat. The actual decrease or increase in the option price for any change in the futures price will depend on the demand for a strike. Also, many are comfortable trading futures. So, despite the marginal edge that options offer, you must continue to trade futures contract if that is your preferred choice.
The call delta increases at an increasing rate when the underlying moves up and decreases at a decreasing rate when the underlying moves down. This varying change in delta is because of the gamma, which accelerates the delta when the underlying moves up and slows the delta when the underlying moves down. Note that you can trade the 50-strike option on the Nifty index as the liquidity is unlikely to be a cause for concern for intra-day trades. Also, we used futures instead of spot index to calculate option delta to make for meaningful comparison between tradable instruments.
The author offers training programmes for individuals to manage their personal investments
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