How to Generate Passive Income through Options Selling-Chapter 5

5.1 Passive Income through Options Selling

Passive income through options selling is a financial strategy that allows investors to generate regular earnings by leveraging the stock market. Options are derivative contracts that provide the buyer with the right, but not the obligation, to buy or sell an underlying asset at a specific price before a set expiration date. As an options seller, your role is to provide this contract to buyers in exchange for a premium—a payment you earn upfront. By implementing carefully planned options strategies, you can create a steady income stream, making it an attractive choice for those seeking financial independence or supplementing other income sources.

One of the primary appeals of options selling lies in its flexibility and the potential for profit regardless of market conditions. Unlike traditional stock investments, which rely solely on price appreciation, selling options enables you to earn income even in sideways or stable markets. Common strategies like covered calls and cash-secured puts focus on managing risk while maximizing returns. These methods involve selling options on stocks or assets you either own or are willing to own, providing a structured way to balance income generation with capital preservation.

However, generating passive income through options selling requires a strong understanding of market dynamics, risk assessment, and discipline. While the premiums received from selling options can be lucrative, they come with obligations, such as delivering stocks or buying them at potentially unfavorable prices. It is essential to build a well-researched approach, monitor market trends, and utilize tools like the Greeks (Delta, Theta, etc.) to manage risk effectively. For individuals willing to invest the time and effort, options selling can evolve into a rewarding endeavor that combines income stability with strategic market engagement.

Why Sell Options?

Selling options is a popular strategy among investors and traders because it offers several potential benefits. Here’s why selling options can be an attractive approach:

1. Generate Passive Income

Selling options allows you to collect a premium upfront, which can serve as a steady source of income. For example, if you sell a covered call on stocks you own, you earn money regardless of whether the option is exercised or expires worthless. This premium adds to your returns and can help build cash flow over time.

2. Benefit from Time Decay (Theta)

Options lose value as they approach expiration due to time decay, and sellers can capitalize on this. For instance, when you sell an option, the gradual erosion of its value (Theta decay) works in your favor. If the buyer doesn’t exercise the option and it expires worthless, you keep the premium as pure profit.

3. Manage Risk with Defined Strategies

While selling naked options carries significant risk, structured strategies such as covered calls and cash-secured puts can mitigate exposure. These approaches involve owning the underlying asset or holding cash reserves, allowing you to manage risk more effectively while still generating income.

4. Profit in Stable or Range-Bound Markets

Selling options is particularly advantageous in markets that are stable or moving sideways. As an options seller, you profit from premiums while the asset’s price remains within a predictable range. This makes selling options suitable even when there are no significant price movements.

5. Complement Long-Term Investment Portfolios

Options selling can work hand-in-hand with long-term investment portfolios. Covered calls, for example, allow you to earn extra income on stocks you already hold, enhancing overall returns without requiring additional capital investment.

6. High Probability of Success

Statistically, many options expire worthless, giving sellers a higher probability of profiting than buyers. This means that the odds often favor sellers, especially when employing conservative strategies with proper risk management.

Common Strategies for Passive Income:

• Covered Calls:Sell call options on stocks you already own.
• Cash-Secured Puts:Sell put options with enough cash in reserve to purchase the stock if needed.
• Iron Condors:Use a combination of selling and buying options to limit risk.

Strategy 1- COVERED CALLS

What are Covered Calls ?

A covered call involves two key actions:

1. Owning the Stock: You must own at least 100 shares of the stock you plan to sell the call option against (since one option contract equals 100 shares).
2. Selling (Writing) a Call Option: You sell a call option with a specific strike price to a buyer. This gives the buyer the right (not obligation) to purchase your shares at the strike price before the expiration date.

In return for selling the call option, you earn a premium, which acts as immediate income.

How Does a Covered Call Work?

Let’s break it down step-by-step:

• Stock Ownership: Suppose you own 100 shares of a company (let’s say Reliance Ltd.), currently trading at ₹500 per share.
• Selling the Call Option: You sell a call option with a strike price of ₹550, for a premium of ₹10 per share. This means you earn ₹1,000 upfront (₹10 x 100 shares).

Scenarios at Expiration:

• Stock Price Remains Below ₹550: The buyer does not exercise the option, and it expires worthless. You keep your shares and the ₹1,000 premium as profit.
• Stock Price Rises Above ₹550: The buyer exercises the option and purchases your shares at ₹550. You still earn the ₹1,000 premium, plus the profit from selling your shares at ₹550 (₹50 per share profit if you originally bought the stock at ₹500).

Why Use Covered Calls?

• Generate Passive Income: Earn regular premiums from selling call options.
• Reduce Risk: The premium acts as a buffer against small price declines in the stock.
• Enhance Portfolio Returns: Utilize your existing stock holdings to generate additional income.

Risks of Covered Calls

While covered calls are relatively conservative, they have limitations:

• Limited Upside Profit: If the stock price skyrockets beyond the strike price, you miss out on the additional gains as your shares will be sold at the strike price.
• Stock Depreciation: If the stock price falls significantly, the premium earned may not cover the losses.

Covered calls are ideal for investors who:

• Own stocks they believe will remain stable or grow modestly.
• Seek additional income without taking on significant risk.
• Are willing to forgo potential upside in exchange for steady income.

 Strategy 2- CASH SECURED PUTS

 Cash-Secured Puts

 A cash-secured put is a conservative options trading strategy that allows investors to generate income while being prepared to purchase a stock at a lower price in the future. It’s called “cash-secured” because the seller of the put option sets aside enough cash to buy the stock if the option is exercised. This strategy is ideal for investors looking to own stocks at discounted prices while earning premiums.

What is a Cash-Secured Put?

A cash-secured put involves the following steps:

1. Sell a Put Option: You sell a put option on a stock you’re willing to buy at a specific strike price.
2. Set Aside Cash: You reserve enough cash to purchase the stock if the buyer exercises their option.
3. Earn Premium: You collect a premium upfront from the buyer, which acts as income for the position.

How Does a Cash-Secured Put Work?

Let’s break it down:

Stock Selection: Choose a stock you believe is fundamentally strong and would be comfortable owning.

Example: ABC Ltd. is currently trading at ₹100.

Sell a Put Option: You sell a put option with a strike price of ₹90 for a premium of ₹5 per share. This means you earn ₹500 upfront (₹5 x 100 shares).

Possible Scenarios:

• Stock Price Remains Above ₹90: The option expires worthless, and you keep the ₹500 premium as profit. You don’t buy the stock, and your cash remains intact.
• Stock Price Falls Below ₹90: The buyer exercises the option, and you purchase 100 shares of ABC Ltd. at ₹90. While you now own the stock, your effective purchase price is ₹85 (strike price minus ₹5 premium), providing a discounted entry.

Why Use Cash-Secured Puts?

• Earn Passive Income: Collect premiums from selling put options.
• Buy Stocks at Discounted Prices: If the option is exercised, the premium reduces your effective purchase price, making this strategy ideal for acquiring stocks you want to hold long-term.
• Risk Management: The strategy ensures you have cash reserved to fulfill your obligation, reducing the risk compared to naked put selling.

Risks of Cash-Secured Puts

• Stock Depreciation: If the stock price drops significantly below the strike price, you may face a paper loss on your newly purchased shares.
• Opportunity Cost: Your cash remains tied up while waiting for the option to expire or be exercised, which may limit flexibility for other investments.

Cash-secured puts are best suited for investors seeking to generate income conservatively while being prepared to purchase stocks they already find appealing. It’s a great strategy for managing risk and adding value to a long-term portfolio.

 Strategy 3-IRON CONDORS

Iron Condors

An iron condor is a neutral options trading strategy often used by advanced traders to generate income in a range-bound market. It involves combining two credit spreads—one bullish and one bearish—on the same underlying asset, allowing traders to profit from time decay (Theta) and low volatility.

What is an Iron Condor?

An iron condor consists of:

Two Call Options:

• Sell a call at a higher strike price.
• Buy a call at an even higher strike price (to limit risk).

Two Put Options:

• Sell a put at a lower strike price.
• Buy a put at an even lower strike price (to limit risk).

The four positions create a “condor-like” risk profile, with maximum profit occurring when the underlying asset’s price remains between the short call and short put strike prices at expiration.

How Does an Iron Condor Work?

Step 1: Sell the Call and Put Options

• Sell a call option with a higher strike price.
• Sell a put option with a lower strike price.
• These positions generate premium income.

Step 2: Buy Protective Options

• Buy a call option with an even higher strike price (to cap potential loss).
• Buy a put option with an even lower strike price (to cap potential loss).
• These options reduce risk if the market moves significantly.

Step 3: Range-Bound Market

• The strategy profits if the underlying asset price stays within the range created by the two short options (strike prices).

Profit and Loss in an Iron Condor

• Maximum Profit: Occurs when the underlying asset price stays between the short call and short put strike prices until expiration. Here, all four options expire worthless, and the trader keeps the premiums collected.
• Maximum Loss: Occurs if the underlying asset price moves outside the range of the bought call or bought put. Loss is limited to the difference between the strikes of the long and short positions, minus the premium collected.

Why Use an Iron Condor?

1. Generate Income: Earn premium income by selling options.
2. Limited Risk: Losses are capped by the protective options, making it safer than selling options outright.
3. Neutral Market View: Ideal for markets with low volatility where the underlying asset price is expected to remain stable.

Example of an Iron Condor

Suppose stock ABC is trading at ₹500:

1. Sell a ₹520 call (Short Call).
2. Buy a ₹540 call (Long Call).
3. Sell a ₹480 put (Short Put).
4. Buy a ₹460 put (Long Put).

• Total premium received: ₹10 (Short Call + Short Put).
• Maximum profit: ₹1,000 (₹10 x 100 shares), if the stock stays between ₹480 and ₹520.
• Maximum loss: Limited to the difference between strikes of either call or put (e.g., ₹20), minus premium received.

Risks of an Iron Condor

• Limited Profits: Potential profit is capped at the premiums received.
• Loss from Significant Moves: If the market becomes highly volatile, losses can occur if the underlying price moves beyond the long options.

Maximizing Passive Income

1. Focus on Theta Decay

Theta is one of the “Greeks” in options trading, representing the rate at which an option loses value as time progresses. This time decay works in favor of options sellers because the closer the option gets to its expiration date, the less value it holds.

• Why Does Theta Decay Matter?

Options have time value, which diminishes as the expiration date approaches. If the underlying asset price stays stable or moves favorably, the buyer of the option faces decreasing probabilities of profiting, leading to lower option values. Sellers benefit by earning the premium upfront and profiting as time erodes the buyer’s chance to exercise the option.

• Application:Focus on selling options with higher Theta values, typically found in at-the-money or near-the-money options. Time decay accelerates as expiration nears, so you profit faster when selling options with shorter durations.

2. Choose the Right Expiration

Selecting the correct expiration date plays a critical role in optimizing your passive income strategy. Options come with varying expiration dates—weekly, monthly, or even long-term.

• Weekly Options:These have short durations and higher Theta decay, making them an excellent choice for frequent income generation. As time decay is more pronounced for options nearing expiration, weekly options allow you to profit quickly. However, they require close monitoring to manage risks effectively.
• Monthly Options:These provide a balance between income generation and risk management, as they allow more time for market movements to align with your strategy. Monthly options can be less volatile compared to weekly ones, making them suitable for conservative traders.

When to Choose Which?

• Opt for weekly options in stable markets with low volatility for faster income.
• Use monthly options if you prefer a less frequent trading routine or if market conditions are uncertain.

3. Volatility Matters

Volatility, measured by the Implied Volatility (IV) of the underlying asset, plays a significant role in determining option premiums. Higher volatility increases the price of options, benefiting sellers by providing larger premiums.

• Why High Volatility is Beneficial:When volatility is high, options prices inflate due to the increased uncertainty in the asset’s future movement. Sellers can take advantage of this by collecting higher premiums while simultaneously managing risk through careful strike price selection and risk mitigation strategies.
• Application:Target selling options during events like earnings announcements or market-wide shifts that temporarily boost volatility. Ensure that the underlying asset’s movement aligns with your strategy to avoid unexpected losses.

5.2 Options Buying vs Options Selling

Options trading offers two fundamental approaches: buying options and selling options, each with distinct strategies, risk profiles, and potential rewards. Let’s explore these two methods in detail to understand their mechanics, advantages, and considerations.

Options trading provides two primary approaches—buying options and selling options—that cater to different risk tolerances, market expectations, and strategies. Understanding these methods in detail is crucial for crafting a trading plan and managing risk effectively. Below is an in-depth comparison between the two:

What is Options Buying?

Options buying involves purchasing either:

1. Call Options: These give the buyer the right (but not obligation) to buy an asset at a specified strike price before expiration. Buyers expect the asset price to rise significantly.
2. Put Options: These give the buyer the right (but not obligation) to sell an asset at a specified strike price before expiration. Buyers expect the asset price to fall sharply.

Key Features:

• Cost:Buyers pay a premium to the seller for this right.
• Profit Potential:For calls, profit can be unlimited if the asset price rises significantly; for puts, the profit potential is large if the asset price drops substantially.
• Risk:Limited to the premium paid, as options can expire worthless if the market doesn’t move as expected.

What is Options Selling?

Options selling involves writing (selling) either:

1. Call Options: Sellers provide the buyer the right to purchase an asset at a specified strike price. Sellers benefit when the asset price stays below the strike price.
2. Put Options: Sellers provide the buyer the right to sell an asset at a specified strike price. Sellers benefit when the asset price stays above the strike price.

Key Features:

• Income Generation:Sellers earn a premium upfront when they sell the option.
• Profit Potential:Maximum profit is limited to the premium collected.
• Risk:Sellers face higher risk, especially in naked positions:

• Naked Calls:Loss potential is unlimited if the asset price rises sharply.
• Naked Puts:Loss occurs if the asset price drops significantly and the seller must purchase the asset at a higher price than its market value.

Risk vs Reward Comparison

Advantages of Each Approach

Options Buying:

1. Low initial cost with limited risk.
2. High reward potential for substantial market moves.
3. Ideal for speculative traders or those hedging existing positions.

Options Selling:

1. Generates passive income through collected premiums.
2. Benefits from time decay (Theta), as options lose value closer to expiration.
3. Higher probability of profit, especially in range-bound or stable markets.

Suitability and Application

• Options Buyers:Suitable for traders who seek speculative opportunities or want to hedge against adverse market moves. Requires lower capital and provides limited risk exposure.
• Options Sellers:Ideal for experienced investors who want steady income and are comfortable managing risks. Requires higher capital and a deep understanding of market dynamics.

5.3 How to scan Stocks for Options Trading?

Scanning stocks for options trading requires a systematic approach to identify assets that align with your trading strategies, risk tolerance, and goals. Here’s a step-by-step guide to help you scan and select stocks effectively:

1. Define Your Criteria

Before scanning stocks, determine the factors important to your trading strategy:

• Volatility:Stocks with higher volatility tend to have larger option premiums, making them attractive for options sellers.
• Liquidity:Look for stocks with active options trading. High liquidity ensures tighter bid-ask spreads and easier entry/exit.
• Price Range:Choose stocks within a price range suitable for your trading style (e.g., higher-priced stocks for spreads or range-bound stocks for iron condors).
• Market Cap:Large-cap stocks typically offer better liquidity and stability, while mid-cap or small-cap stocks may provide higher volatility.

2. Use Screening Tools

Leverage stock-screening platforms or brokerage tools to filter stocks based on your criteria. Popular tools include:

• Implied Volatility (IV):Look for stocks with high IV if you want larger premiums.
• Open Interest and Volume:Analyze these metrics to ensure the options contracts are actively traded.
• Fundamental Data:Filter stocks by fundamentals such as revenue growth, earnings consistency, or dividend yield if you’re combining options trading with long-term investing.

3. Scan for High Volatility

Stocks or ETFs with high implied volatility (IV) are ideal for options trading strategies like straddles or strangles. Focus on events like:

• Earnings announcements.
• Macroeconomic data releases.
• Sector-specific news or developments.

4. Explore Stable Stocks for Range-Bound Strategies

If you’re deploying strategies such as covered calls or iron condors, look for stocks with stable price movements. Use technical indicators such as:

• Bollinger Bands: To find range-bound stocks.
• Moving Averages: To identify trend stability.
• Relative Strength Index (RSI): To assess overbought/oversold levels.

5. Analyze Liquidity Metrics

Ensure the stock’s options contracts have sufficient liquidity:

• Check Open Interest: Higher open interest indicates greater market activity in specific options contracts.
• Review Volume: High trading volume ensures smoother transaction execution and tighter spreads.

6. Monitor Sector Trends

Scanning stocks within specific sectors can reveal opportunities:

• Tech stocks: High volatility and growth potential.
• Consumer staples: Stability, suitable for conservative strategies.
• Finance: Favorable for dividend-based strategies alongside options.

7. Use Predefined Scans

Many brokerage platforms offer predefined scans to identify stocks suitable for options trading. For example:

• High implied volatility scan.
• Stocks with upcoming earnings reports.
• Most active options for the day.

8. Regularly Review Market News

Stay updated on market trends, earnings reports, and macroeconomic news. Events that impact stocks’ volatility and prices can open opportunities for options trades..

How 5 paisa helps to scan stocks in Options Trading

The 5paisa FNO 360 trading platform provides tools and features to assist traders in scanning stocks for options trading through its user-friendly interface and advanced functionalities. Here’s how it supports traders:

1. Options Chain Analysis: 5paisa offers a detailed options chain that displays strike prices, premiums, and Greeks (like Delta, Theta, Vega). This helps traders analyze contracts and make informed decisions.
2. Stock Screening Tools: The platform includes stock screeners to filter stocks based on criteria such as implied volatility, liquidity, and price movements. These tools are essential for identifying stocks suitable for options strategies.
3. Predefined Strategies: 5paisa simplifies options trading by providing predefined strategies like covered calls, iron condors, and straddles. Traders can execute these strategies directly through the platform.
4. Real-Time Data: The platform provides real-time market data, including price movements and volatility metrics, enabling traders to react quickly to market changes.

5.4 How to determine Correct Entry , Exit and Stop Loss In Options Trading

Determining the correct entry, exit, and stop-loss levels in options trading is a crucial part of ensuring successful trades. This process involves a mix of technical analysis, strategy, and risk management tailored to your trading style.

• Determining the Correct Entry Point:

The entry point is all about timing your trade to capitalize on price movements effectively. To find the right entry, a trader needs to analyze the underlying stock or index and identify the ideal moment to initiate a position.

• Trend Analysis

One approach is trend analysis. A trader first determines whether the asset is in an uptrend, downtrend, or range-bound movement. Tools like moving averages are commonly used to identify trends. For example, if the price of the underlying stock is above its 50-day moving average, it indicates an uptrend, signaling a potential entry for a call option. Conversely, if the price is below the moving average, a put option might be more suitable.

• Support and Resistance

Support and resistance levels also play a vital role. Support is a price level where the stock has historically reversed upward, while resistance is where it has reversed downward. For entry, traders often watch for the price to bounce off a strong support level for a call option or to face resistance for a put option.

• Breakouts

Breakouts provide another opportunity for entry. If the stock price breaks above a resistance level with strong volume, it may be a good time to buy a call option. Similarly, a price breaking below support might signal an entry for a put option. Confirming breakouts with indicators such as volume spikes ensures that the move is genuine.

• Momentum Indicators

Additionally, momentum indicators like the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD) are widely used to refine entries. For instance, an RSI reading below 30 may indicate an oversold condition, suggesting a buying opportunity, while a MACD bullish crossover could affirm an uptrend.

Determining the Correct Exit Point:

• Exiting a trade is just as critical as entering it, if not more so. Successful traders always have a clear exit strategy in mind before initiating a trade. The goal is to maximize profits while protecting against potential losses.
• One common method is setting a profit target. This involves deciding on a specific price level or percentage return at which you will exit the trade. For example, if you enter a trade expecting a 20% return, you would exit once that target is achieved.
• Technical analysis plays an integral role in timing exits. If the stock price approaches a key resistance level while you hold a call option, it might be a good time to exit and lock in your profits. Similarly, for a put option, consider exiting when the stock price nears a significant support level.
• Trailing stops are another excellent tool for managing exits. With a trailing stop, you set a percentage or dollar amount below the current price that adjusts as the stock price moves in your favor. This ensures you capture profits while allowing the trade to continue benefiting from positive movements.
• For options traders, time decay (Theta) is a crucial factor. Options lose value as expiration approaches, especially if they are out-of-the-money. Exiting before significant time decay occurs is important to preserve premium value.

Determining Stop-Loss Levels:

• A stop-loss is your safety net, designed to limit potential losses in case the trade moves against you. It helps prevent emotional decision-making during volatile market conditions.
• Setting a stop-loss can be done using several techniques. A percentage-based stop-loss involves deciding what percentage of your capital you are willing to risk on a trade. For instance, if you risk 2% of your portfolio on each trade, you calculate the maximum loss you can tolerate and place the stop-loss accordingly.
• Another approach involves using technical levels. For call options, you might set your stop-loss below a key support level, as a break below this level would indicate a bearish move. For put options, the stop-loss might be set above a resistance level.
• In options trading, the premium you pay for the contract can also guide your stop-loss. Define the maximum premium loss you are willing to accept and exit the trade if the option price falls below this level.
• Volatility should also factor into your stop-loss strategy. During periods of high volatility, prices can swing more dramatically, so it may be necessary to widen your stop-loss levels to avoid premature exits. Conversely, in low-volatility environments, tighter stop-losses can be employed.

Integrating Risk Management:

• Risk management ties all these strategies together. A good options trader knows that not every trade will be profitable, so the goal is to limit losses while allowing profits to grow. This involves diversifying your trades, avoiding over-leveraging, and sticking to a disciplined approach.
• By setting clear entry, exit, and stop-loss levels, you create a structured trading plan that minimizes emotional decisions. Always backtest your strategies using historical data to validate your approach and refine it based on market conditions.

Covered Call: High Delta + High Theta = Income Strategy

Imagine you own 100 shares of TCS at ₹3,500 per share. You want to generate some extra income without selling the stock, so you decide to sell a call option.

Step 1: Selling the Call Option

• You sell a ₹3,600 call option expiring in 2 weeks.
• You collect ₹50 per share as premium.

Step 2: Understanding Delta and Theta

• Since you own the stock, your Delta is +1 per share (total +100 for 100 shares).
• The sold call reduces Delta slightly, making it about +80.
• Theta = ₹5 per day, meaning you earn ₹500 daily as time decay works in your favor.

How You Make Money

Scenario 1: Stock Stays Below ₹3,600 → Maximum Profit

• The option expires worthless.
• You keep the ₹50 per share premium (₹5,000 total).
• You also earned ₹500 per day from Theta (₹7,000 total in 14 days).
• Total profit = ₹12,000 without selling your TCS stock.

Scenario 2: Stock Rises Above ₹3,600

• Your TCS shares will likely be sold at ₹3,600, meaning you profit ₹100 per share (₹10,000 total).
• You still keep the ₹50 per share premium (₹5,000).
• Total maximum profit = ₹15,000.

Why This Strategy Works

• Earn extra income every day (time decay).
• Still make money if stock goes up (but profit is capped).
• Best for sideways or slightly bullish markets.

Cash-Secured Put: Vega Exposure + Delta Buffer

Imagine you want to buy 100 shares of TCS, but the current price is ₹4,000 per share—a little expensive. Instead of buying it outright, you use a cash-secured put strategy to potentially get the stock at a lower price while earning income.

Step 1: Selling the Put Option

• You sell a ₹3,900 put option expiring in 2 weeks.
• You collect a ₹60 premium per share (₹6,000 total for 100 shares).
• You must have ₹3,90,000 in your account to buy the shares if needed.

Step 2: Understanding Delta and IV

• Delta ≈ -0.30 → This means the stock can drop slightly and you still win.

• High implied volatility (IV) means higher premium → If IV is high, you earn more income.

Possible Outcomes

Scenario 1: Stock Stays Above ₹3,900 → Maximum Profit

• The option expires worthless, and you keep the ₹6,000 premium.
• You don’t need to buy TCS, but still made money.

Scenario 2: Stock Falls Below ₹3,900 → You Buy TCS at a Discount

• If assigned, you must buy TCS at ₹3,900.
• But since you earned ₹60 per share in premium, your effective cost is ₹3,840 per share (₹3,90,000 – ₹6,000).
• This is better than buying at ₹4,000 directly.

Why Use This Strategy?

• Earn extra money without owning the stock.
• If stock drops, you buy at a lower price instead of market price.
• Works best when you want to own the stock but at a cheaper price.

Iron Condor: High Theta, Neutral Delta, Low Vega

Example: Iron Condor on Reliance

Reliance is currently trading at ₹2,500 per share. You believe it will stay within a range over the next two weeks. To earn income, you set up an Iron Condor by selling both a call spread and a put spread.

Step 1: Selling the Call & Put Options

• Sell a ₹2,600 Call (expecting stock won’t go higher).
• Sell a ₹2,400 Put (expecting stock won’t go lower).
• Buy a ₹2,650 Call (to limit risk).
• Buy a ₹2,350 Put (to limit risk).

Step 2: Understanding Delta, Theta, and Vega

• Delta ≈ 0 → Market Neutral (no strong direction bias).
• Theta = ₹6 per day → You earn money daily from time decay.
• Vega is negative → If IV drops, the trade benefits.

Possible Outcomes

Scenario 1: Reliance Stays Between ₹2,400 – ₹2,600 → Maximum Profit

• Both call and put options expire worthless.
• You keep the ₹100 premium earned.
• Total profit = ₹10,000 for 100 shares.

Scenario 2: Reliance Moves Outside the Range → Limited Loss

• If Reliance goes above ₹2,600 or below ₹2,400, losses happen but are controlled due to the protective options.

Why Use This Strategy?

• Earn income in a range-bound market.
• Limited risk due to buying protective options.
• Best when volatility is high and expected to drop.

5.5  Probability-Based View of Popular FnO Strategies

Max Profit

• Covered Call: You earn the premium + any stock gain up to the strike price.
  g., Sell a ₹100 call on stock bought at ₹95 → max profit = ₹5 + premium.
• Cash-Secured Put: You keep the premium if the stock stays above the strike.
  g., Sell a ₹90 put for ₹2 → profit = ₹2 if stock stays above ₹90.
• Iron Condor: You earn the net premium if the stock stays within both short strikes.
  g., Net premium = ₹8, short strikes are 100 & 120 → you earn ₹8 if stock stays between.

 Max Loss

• Covered Call: Unlimited downside in stock, minus premium.
  If stock crashes, losses grow beyond breakeven.
• Cash-Secured Put: You could be assigned the stock and take a hit.
  Worst-case: stock goes to zero.
• Iron Condor: Defined risk = difference between strikes − premium collected.
  g., If spread = ₹10, premium = ₹3 → max loss = ₹7.

 POP (Probability of Profit)

This shows the estimated chance of the strategy ending profitable at expiry.

• Covered Call: ~70% if stock is stable or mildly bullish.
• Cash-Secured Put: ~65–75% depending on strike and volatility.
• Iron Condor: ~70% if placed wide and in high IV environments.

Higher POP usually means lower reward per trade, but more consistent income.

ROI (Return on Margin)

Based on the margin or capital used, not on the full notional value.

• Covered Call: 1–3% monthly income potential if stock moves favorably.
• Cash-Secured Put: 1–2% per month on capital held.
• Iron Condor: 5–8% is possible due to leverage and defined risk.

Example Breakdown: Iron Condor

• Nifty at 22,000
• Sell 21,800 Put & 22,200 Call
• Buy 21,700 Put & 22,300 Call
• Net Credit = ₹100
• Strike width = 100 points
• Max Loss = ₹100 – ₹10 (credit) = ₹90
• POP≈ 70% (based on probability of staying in range)
• ROI= ₹10/₹90 ≈ 11% return for that position, possibly over 30 days

5.6  Common Mistakes New Option Sellers Make

Option selling can offer consistent income, but risk management is everything. Many new traders get seduced by the premium and overlook structural pitfalls. Here’s a blunt look at common missteps:

1. Selling Naked Calls Without Hedging
   • Reality: Unlimited risk if the stock surges.
   • Mistake: Traders think the stock “won’t go that high” — until it does.
   • Example: Sold a ₹100 call on a volatile stock that gaps to ₹120 — loss = ₹20+ per share, with no cap.
   • Better Approach: Always pair with a long call (bear call spread) or define your risk.

2. Ignoring IV Crush After Events (Earnings, News)

• Reality: Implied Volatility (IV) often spikes before events and collapses after, regardless of direction.
• Mistake: Selling options post-event when IV has already dropped — you collect low premium with high directional risk.
• Example: After earnings, IV drops from 40% to 20% — premiums collapse, hurting sellers who entered late.
• Better Approach: Sell before the event if IV is high, or avoid selling right after.

3. Choosing Short Expiries Without Liquidity

• Reality: Illiquid weekly options = wide bid-ask spreads = bad fills.
• Mistake: Trying to scalp theta decay from options that are hard to trade or adjust.
• Example: A ₹2.00 bid/₹4.00 ask means you lose before you begin — execution matters.
• Better Approach: Stick to liquid expiries (monthly or weekly on index stocks) and monitor open interest/volume.

 Strategy-Specific Risks: No Sugarcoating

5.7 Strategy Suitability Based on Market Conditions

Smart trading is dynamic. The best traders don’t just know strategies — they know when to use them. The right option strategy depends on:

• Market trend (bullish, bearish, neutral)
• Volatility levels (rising, falling, stable)
• Risk appetite and capital availability

Match Strategy to Market View

Why This Matters

New traders often apply the same strategy over and over, regardless of context. That’s a mistake.

Example 1: Neutral Market

• Trader sells naked calls thinking the stock won’t move.
• Suddenly, earnings surprise → stock gaps up → losses explode.

Better strategy? 

Use an Iron Condor or Calendar Spread — you win from time decay or IV drop, with defined risk.

Example 2: Bullish Market

• Trader sells puts far OTM — collects premium.
• Stock keeps rising → they miss out on full upside.

Better strategy? 

Use Cash-Secured Put to potentially buy low, or a lower-strike Covered Call to earn income while holding.

Dynamic Thinking Is Key

A fixed strategy can’t survive a shifting market. Ask yourself before every trade:

1. What’s my directional view?
2. What’s implied volatility doing?
3. Is the market trending or chopping?
4. Am I risking capital or protecting it?

5.8 Entry/Exit Using Decision Trees

• When exactly should I enter?
• What conditions improve the odds?
• What signs tell me to stay out or exit early?

1. Setup Conditions:

2. Volatility Filters

Use IV Percentile, not just IV. A stock can have low IV, but high relative IV, which makes premium selling still attractive.

3. Greek Thresholds for Entry/Exit

 How to Use This in Real Trading

 Example 1: Entering a Cash-Secured Put

• RSI = 28 → oversold
• Stock at strong support
• IV Percentile = 75 → high premium
• Delta = -0.25 → good cushion

Sell a Put or Cash-Secured Put

Example 2: Avoiding an Iron Condor

• IV Percentile = 20 (very low)
• Earnings event in 2 days
• Vega risk high due to low IV base

Avoid Iron Condor — poor premium, high Vega exposure

Example 3: Passive Income Setup

• Delta ≈ 0
• Theta = ₹125/day
• IV = elevated but stable

 Ideal for Iron Condor / Calendar Spread

5.9  Position Sizing & Capital Planning for FnO Strategies

“It’s not just what you trade — it’s how much and where it fits in your portfolio.”

Many traders fail not because their strategy is wrong, but because they over-allocate or concentrate risk. This section helps you:

• Allocate capital intelligently.
• Diversify strategy exposure.
• Limit drawdowns from a single mistake.

 Capital Allocation Table

Risk Management Tip: The 3% Rule

Never risk more than 3% of your total capital on a single trade.

Why?

Because even if you’re wrong 5 times in a row, your capital won’t be destroyed. Here’s how to apply it:

Example:

• Total capital = ₹5,00,000
• Max risk per trade (3%) = ₹15,000

That means:

• If doing an Iron Condor, choose strike widths and quantities that don’t exceed ₹15K max loss.
• For CSP or Covered Call, ensure the stock you’re trading fits within the 3% risk cap (accounting for gap-down or assignment risk).

Portfolio Allocation Logic

5.10 Trade Count Planning Based on Capital

Always maintain a cash buffer (10–20%) to handle adjustments, rollovers, or new opportunities.

 Rolling & Adjustment Techniques in Options

1. Rolling Up a Covered Call (When Stock Rallies)

Problem: Stock shoots past your call strike → you cap profits.

Solution: Roll up (and possibly out) the call.

When to Roll:

• • Stock moves close to or beyond call strike.
  • You want to hold the stock (not get assigned).
  • IV still elevated (premium available).

How to Roll:

• • Buy backcurrent call (e.g., ₹150 strike, expiring this Friday).
  • Sella higher strike (e.g., ₹160) with more time (next week/month).

Example:

• • You own Stock ABC @ ₹140
  • You sold ₹150 CE, it’s now at ₹155
  • Roll from 150 CE (expiring soon) to 160 CE (next expiry) for ₹5 credit

This gives you:

• • Room for more stock upside
  • Additional premium
  • Deferred assignment

2. Rolling Down a Put (When Market Drops)

Problem: Stock/index falls toward your short put → risk of breach.

Solution: Roll down the put strike to stay safer, collect more premium.

When to Roll:

• • Underlying nears or crosses your put strike.
  • Market is weak; you don’t want to be assigned.
  • There’s still decent time premium left to roll.

How to Roll:

• • Buy backcurrent put (e.g., ₹18,000 PE).
  • Selllower strike put (e.g., ₹17,700) — same expiry or extend.

Example:

• • Sold 18,000 PE, Nifty drops to 17,950
  • Roll to 17,700 PE (same or next week) → reduces breach risk + collects extra premium

This helps you:

• • Avoid deep ITM risk
  • Stay in trade longer
  • Improve breakeven

3. Closing Iron Condors Early (for 50–70% Profit)

Why: Most of the theta decay happens early — don’t wait for max profit and risk reversal.

When to Exit Early:

• • You’ve earned 50–70% of the max profit
  • Market remains range-bound
  • IV drops or time decay works fast

Example:

• • Iron Condor max profit = ₹5,000
  • You’re sitting on ₹3,500 profit (~70%) with 10 days left

Summary Table: Rolling/Adjustment Tactics

5.11 Tools and Scanners — What to Use & What to Look For

What to Look For — Smart Option-Selling Filters