Advanced Options Trading Strategies: Generalization, Delta, Strike Selection, and Effect of Volatility

  1. Learn about Option Strategies
    1. option trading strategies top 18 strategies every investor should know
    2. Bull call spread how Options Trading Strategy Works
    3. What is Bull Call Spread? How to Use Options Trading Strategy for Stocks and Indices
    4. Spreads in Finance A Comprehensive Guide to Mastering Options Trading Strategies
    5. Bull Put Spread Step-by-Step Guide How to Execute Options Trading Strategy with Examples
    6. Call Ratio Back Spread Options Trading Strategy: Explained with Examples
    7. Understanding Call Ratio Back Spread Strategy and the Importance of Time to Expiry and Volatility
    8. Bear Call Ladder Strategy: Tips to Improve Your Share Trading Success
    9. Synthetic Long and Arbitrage Strategies in Nifty Futures with Options
    10. Arbitrage options trading strategy with Examples from Fish Market to Share Market
    11. Bear Put Spread Navigating Bearish Markets to Limit Losses
    12. Bear Call Spread Why Calls can be a Better Choice than Puts
    13. Put Ratio Back Spread Options Trading Strategy to Profit from a Bearish Market
    14. Advanced Options Trading Strategies: Generalization, Delta, Strike Selection, and Effect of Volatility
    15. Long Straddle Options Trading Strategy Maximizing Profits in Any Market Direction
    16. Straddle Options Strategy Understanding Volatility and Overcoming Potential Risks
    17. Short Straddle Options Trading Strategy with examples
    18. Strangle vs Straddle: Which Options Trading Strategy is Better
    19. Long Strangles vs Short Strangles: Which Options Trading Strategy is Right for You
    20. Max Pain how to use options strategy With Examples
    21. Put Call Ratio (PCR) Analysis: How to Identify Bullish or Bearish Trends in the Market
    22. Iron Condor How to use Options Strategy With examples
    23. Everything about Max P&L and ROI and Logistics
Marketopedia / Learn about Option Strategies / Advanced Options Trading Strategies: Generalization, Delta, Strike Selection, and Effect of Volatility

Strategy generalization

We can generalize the key strategy levels as below –

  1. Spread = Higher Strike – lower strike
    1. 7500 – 7200 = 300
  2. Max loss = Spread – Net credit
    1. 300 – 42 = 258
  3. Max Loss occurs at = Lower strike price
  4. Lower Breakeven point = Lower strike – Max loss
    1. 7200 – 258 = 6942
  5. Upper breakeven point = Lower strike + Max loss
    1. 7200 + 258 = 7458

– Delta, strike selection, and effect of volatility

We know that this strategy is more profitable in a declining market. To check this, we can do some calculations to determine the delta of the overall strategy.

  • 7500 PE is ITM option, delta is – 0.55. However since we have written the option, the delta is –(-0.55) = +0.55
  • 7200 PE is OTM, has a delta of – 0.29, remember we are long two lots here
  • The overall position delta would be +0.55 + (-0.29) +(-0.29) = – 0.03

The Delta value gives away that the strategy is indeed attuned to changes in the market’s direction (albeit weakly). The negative sign suggests it profits when conditions take a downturn.

I’d recommend that when it comes to strikes, you employ the traditional tandem of ITM and OTM options. Remember, the trade must be done as a ‘Net Credit’. Executing this tactic with a net outflow of cash is not advised.

Let’s look at the variation in volatility and its effect on the strategy –

We can use the three coloured lines to observe the relationship between “premium value” and volatility. This allows us to comprehend how different levels of volatility affect a strategy, while taking time-to-expiry into account.

  1. Blue Line – When the time to expiry is increased and volatility rises, it could be advantageous for a Put ratio back spread. From -57 to +10, the strategy’s payoff increases when volatility goes up from 15% to 30%. This shows that if you are bearish on the stock but have plenty of time before expiry, you would need to consider the degree of volatility as well. Therefore, I might be reticent to implement this approach at the series’ outset with extremely high volatility (higher than twice that of usual).
  2. Green line – This green line shows that an increment in volatility when there are around 15 days left until expiry yields some benefit, though it isn’t as pronounced as previously. We can observe that the strategy return rises from -77 to -47 when volatility rises from 15% to 30%.

Red line – As we near expiry, the premium value does not change too much in spite of volatility increasing. In this scenario, you only need to consider the direction that the security will take and can disregard any fluctuations in its volatility.