Technical Analysis

An option to make money

GURUMURTHY K | Updated on January 24, 2018

Options trading has been in the limelight in the Indian market for the last few years. A call option gives the holder the right, but not an obligation to buy the underlying asset at a specified price. On the other hand, a put option gives the holder the right but not an obligation to sell the underlying asset at a specified price. A normal buying and selling of either a call or a put option is very common among traders. But, short-selling — that is selling either a call or a put option at a higher price and then buying it back at a lower price to make profit — is not very common. This act of short-selling is also termed as “option writing”; in technical terms, it is called “naked shorting”.

High margin cost

So who can write an option? Anybody who trades in the option can short-sell the option. But most retail traders do not prefer to do so. The reason is the high margin cost involved in the transaction. When an option is bought, no margin money is required and only the premium has to be paid. But while shorting an option, one needs to put up margin money which is substantial. For instance, buying one lot of a Nifty 8,700 call option at ₹155 requires a total amount of ₹7,750. But shorting the same option will mean a margin amount of ₹34,303.

Also, the amount of margin money required will be known only after the transaction is done. Zerodha, a discount brokerage firm, however provides an online option margin calculator called the SPAN which helps compute the quantum of margin money for a particular transaction. Nithin Kamath, founder and CEO of Zerodha, says, “because of the high margin cost, only high networth individuals and institutional traders write options”.

Risk involved

The major risk involved in option writing is that the quantum of loss is unlimited. For example, if a trader is bearish on the market and shorts a 9,000 Nifty call at ₹150, he receives ₹7,500 as premium from the option buyer. On the date of expiry, if the Nifty moves up to, say, 9,800 and the value of the call is ₹800, then the option writer would have to buy back the option by paying ₹40,000 (market lot is 50). So, the net loss will be ₹32,500 (₹40,000 less premium of ₹7,500 ). The loss could be much higher if the Nifty rallies sharply.

Does this mean that retail traders wary of huge losses should keep away from option writing altogether? Not necessarily. “Keep strict stop-loss and avoid overleveraging while shorting options,” says Nithin.

Also, market data suggests that option writers make a bigger pie in the market as far as overall gains are concerned. This is because most of the options are not executed and go worthless at the time of expiry. For example, on January 29, the expiry day for the January series options, the total number of open contracts (open interest) were 81,061,325. Out of this, 70,207,325 contracts (accounting for about 87 per cent) expired worthless.

Published on February 08, 2015

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