Shubham Agarwal
Options are looked at as excellent instruments for taking trades as well as hedging risk on trading as well as investment positions. However, we can also use Options to lock profits. The issue at hand is that we now stand with major index Nifty sitting on little less than 10% rise from the recent bottom.
At this juncture anyone taking a Buy position would be a little cautious. Well, nothing wrong in being cautious. However, in an attempt to concentrate on the most confident ideas, many trading opportunities are left for being risky.
The Profit Locker that we will discuss takes care of this as well as the ultimate fear of what if the market falls apart by opening gap down not even giving you an opportunity to trigger your stop loss. We will achieve this in three steps.
Step 1# Buy the First Lock
While ascertaining and maintaining your Stop Loss level, Buy a Future + Put Option with strike closest to the current market price. This will make sure of two things:
1. In case of a big drop we are saved with a Known Possible maximum loss. So, now we can trade all the risky ideas as well
2. If we do happen to hit our stop loss we will have a bit of compensation from Put option bought
Step#2 If the Stop Loss does not trigger and Position moves into Profit
Square up the Put option bought before and Buy another Put option now with a Higher Strike Price (closer to the current market).
This will help with locking profits to the strike price that we have now bought.
Step #3 Keep repeating Step#2 every time there is an additional increase
Every increase that pushes the future to the Strike Price of Put at least 1-2 strikes higher than the Put strike we have bought, we can push the Put upwards.
Needless to say, if we do hit stop loss in this entire journey we get out of the entire position.
Now for the trade-off. Everything comes at a cost. The cost of this protected trading and profit locking is the cost of Put Option. Account for at least 2-5% cost depending upon the duration of trade. One good thing to deploy this Profit Locker in a rising market is that due to lower risk levels the option premiums are also low.
One more thing one can argue is that this very much looks like a Synthetic Call. Meaning,
Buy Future + Buy Put (Strike of close to Current Price) = Buy Call Strike (close to current price)
However, this strategy has worked for me more because firstly the liquidity in Lower Strike Calls (after the rise in the price) is much worse than liquidity in Lower Strike Puts.
Secondly, we do have a bit of flexibility with Puts with futures position intact; we get more committed to the trades and less tempted to book small profits and run away.
This is one of most unique utilities of Options that helps us improve the pay-off and risk-taking ability by just associating one more position to our buy trades.
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