The idea of defining risk limits in trading is common among traders. Let us understand better with the help of this example.
Suppose a trader has Rs 3,00,000 capital in his trading account and the Nifty Futures contract requires a margin of approximately Rs 1,65,000. If you need help to calculate the margin required for any F&O contract, then go ahead and use a SPAN calculator. To protect himself from undue exposure and losses, the trader may decide not to hold more than 5 Nifty Futures contracts at any given point in time; this way he will be able to define his own risk limits easily and it works quite well with futures trading strategies.
But does this form of risk management apply to options trading? Let’s investigate whether it is the right approach.
Here is a situation:
The quantity of trades conducted is equal to 10 lots. Please note that 10 lots of at-the-money (ATM) contracts, with each contract having a delta of 0.5, is equivalent to 5 futures contracts
Option = 24,800 CE
Spot = 24,820
Delta = 0.5
Gamma = 0.005
Position = Short
The trader is currently short 10 lots of Nifty 24,800 Call Option, which falls within their predefined risk parameters. As we discussed previously in the Delta chapter, we can sum up the position’s deltas to get the overall delta. It is also important to note that a delta value of 1 is equivalent to one lot of underlying. Therefore by keeping this in mind, we can figure out the net delta for this position.
Delta = 0.5
Number of lots = 10
Position Delta = 5 i.e. (10 × 0.5)
From a delta perspective, the trader must not exceed trading 5 Futures lots. Additionally, it should be noted that because the trader is short on options, he is also short gamma.
This 5-point delta means that a shift of one point in the underlying causes the trader’s position to change by five.
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