Option Trading In Sideways Market: A stock market is an unpredictable place that responds rapidly to changing economic conditions, news events, and other factors. The market responds to these changes through the change in prices of the securities causing bullish or bearish trends in the market.
Traders make use of these trends to enter bullish and bearish positions and try to earn profits in the market. But more often than not, markets tend to trade in a sideways direction.
In times when the markets are moving within a narrow range, you must wonder how you can place a trade and earn profits. The answer is, through options strategies.
In this article, we are going to show you various strategies through which you can do Option trading in sideways market.
Option Trading In Sideways Market
Options trading provides the stock market participants to gain exposure to the stocks without having to own the shares. Here, the participants can buy a call or write a put when they are bullish on the underlying asset and can buy a put or write a call when they are bearish on the underlying asset.
One can even employ options strategies according to their prediction of price movements by opening multiple contracts in various strike prices. These strategies will even make it possible for you to do option trading in a sideways market. Following are the sideways strategies you can employ
Also Read: Best Options Trading Courses For Beginners
1. Short Straddle Option Strategies:
A short straddle is a neutral options strategy that consists of selling one call and one put option. Here, the call and put options that are sold should be At money Option contracts of the same strike price and should have the same expiration date.
In this strategy, you will profit from the premium received from selling/writing both call and put options and you will remain in profit as long the price underlying asset remains in the range of the strike price.
Since the option contracts written are At the Money, the premium you will receive is quite high. At the same time, the profit in this strategy is limited to the premium received.
The writer (seller) also has the potential to incur unlimited losses if the underlying asset start moving away from the strike price
Note: The break-even point (BEP) is a point where you are neither in a profit nor a loss
There are two break-even points in this strategy, that is, if the spot price starts rising and if the sport price starts declining.
- If the spot price starts increasing, BEP= Strike price + Total Premium Received
- If the spot price starts decreasing, BEP= Strike price – Total Premium Received
Short Straddle Strategy Example: Suppose the spot price of NIfty 50 is 18000. You sell one call option and one put option at the strike price of 18000 and receive a premium of 150 units
If the spot price starts increasing, the break-even point would be 18000+150= 18150. You will start incurring a loss beyond this point.
If the spot price starts decreasing, the break-even point would be 18000-150= 17850. You will start incurring unlimited losses beyond this point.
So, your safety net would be in the range of 17850 to 18150.
2. Short Strangle Option Strategies:
A short strangle is a neutral options strategy that also consists of selling one call and put option each. But here, the call and put options that are sold should be out-of-money of equal range away from the stop price and should have the same expiration date.
Here, the option writer will profit from this strategy as long the price of the underlying assets remains within the range of out-of-money contracts sold.
As compared to Short Straddle, the premium received in Shorting Strangle is lesser.
When the spot price of the underlying asset starts moving either above the call option sold or below the put option sold, the writer of the option will start incurring losses.
There are two BEP (Break Even Points) in this strategy:
- If the spot price starts increasing, BEP= Call Strike price + Total Premium Received
- If the spot price starts decreasing, BEP=Put Strike price – Total Premium Received
Short Strangle Strategy Example:
Suppose the spot price of NIfty 50 is 18000. You sell one call option and one put option at the strike price of 18200 and 17800 by receiving a total premium of Rs. 70.
If the spot price starts increasing, the break-even point would be 18200+70= 18270. You will start incurring a loss beyond this point.
If the spot price starts decreasing, the break-even point would be 17800-70= 17730. You will start incurring unlimited losses beyond this point.
Read More: How to Use Short Strangle Option Strategy in Trading?
3. Iron Condor Option Strategies:
Iron Condor strategy is a combination of two vertical spreads that is, the bear call spread and a bull put spread.
There are four legs involved in this strategy:
- Sell one Out of Money Put Option
- Buy one Deep Out of Money Put Option
- Sell one Out of Money Call Option
- Buy one Deep Out of Money Call Option
The premium received in this strategy is comparatively less than what you receive in a Strangle strategy. But at the same time, the losses incurred are limited even if the underlying price moves beyond the contracts written. This is because the out-of-money options that are bought will nullify the losses of the options sold when the spot price reaches the option that is bought.
Here are the two break-even points in this strategy if the spot price starts rising and if the sport price starts declining.
- If the spot price starts increasing, BEP= Short Call Strike price + Net Premium Received
- If the spot price starts decreasing, BEP=Short Put Strike price – Net Premium Received
Iron Condor Strategy Example:
Suppose the spot price of NIfty 50 is 18000.
To implement this strategy, you enter into the following contracts:
- Sell one call option and one put option at the strike price of 18100 and 17900 respectively, by receiving a total premium of 100 units.
- Buy one call option and one put option at the strike price of 18150 and 17850 by paying a net premium of 70 units.
If the spot price starts increasing, BEP = 18100 + (100 – 70) = 18130
If the spot price starts decreasing, BEP = 17900 – (100 – 70) = 17870
4. Long Butterfly Spread Option Strategies:
The Long Butterfly Spread is a four-legged option strategy that can be executed in two ways, it can either be done by execution of call contracts or execution of put contracts.
This Strategy involves buying one out-of-money option, selling two at-the-money options, and buying one in-the-money option.
The options bought and sold should either consist entirely of call contracts or entirely of put contracts. This is a net debit strategy where both the profits and losses are limited.
The maximum profit that can be earned in this strategy is when the price of the underlying asset is equal to the strike price where you have written the 2 contracts.
The maximum loss that can be incurred in the strategy is when the price of the underlying asset goes below the lowest strike price bought or above the highest strike price that is bought.
Here are the two break-even points in this strategy, if the spot price starts rising and if the sport price starts declining.
If the spot price starts increasing, BEP= Long Call/Put Strike price – Net Premium Received
If the spot price starts decreasing, BEP=Long Call/Put Strike price + Net Premium Received
Example for long call butterfly spread:
Suppose the spot price of NIfty 50 is 18000.
To implement this strategy, you enter into the following contracts:
- Buy one call option at the strike price of 17950 by paying a total premium of Rs.100
- Sell 2 call options at the strike price of 18000 and receive a premium of Rs.140
- Buy one call option at the strike price of 18050 and pay a premium of Rs.30.
If the spot price starts increasing, BEP = 18050 – (140 – 100 – 30) = 18040
If the spot price starts decreasing, BEP = 17950 + (140 – 100 – 30) = 17960
Long Butterfly Option Strategy Example:
Suppose the spot price of NIfty 50 is 18000.
To implement this strategy, you enter into the following contracts:
- Buy one put option at the strike price of 17950 by paying a total premium of Rs.30
- Sell 2 put options at the strike price of 18000 and receive a premium of Rs.140
- Buy one put option at the strike price of 18050 and pay a premium of Rs.100.
If the spot price starts increasing, BEP = 18050 – (140 – 100 – 30) = 18040
If the spot price starts decreasing, BEP = 17950 + (140 – 100 – 30) = 17960
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In Closing
In this article, we covered various options strategies that can help you do Option trading in sideways market.
Though the sideways market can be a challenging time for traders to place good trades, option trading strategies can provide you with opportunities to earn decent profits. But one should be aware of all the risks involved while trading in options and monitor trades closely to make timely adjustments if necessary.
FAQ
1. Which indicator works best in sideways market?
In a sideways market, oscillators such as the Relative Strength Index (RSI) or the Moving Average Convergence Divergence (MACD) tend to work well as they can help identify overbought and oversold conditions within the range-bound price action.
2. How long can the market go sideways?
The duration of a sideways market can vary significantly. It can last for a few weeks to several months, depending on various factors such as market conditions, economic events, and investor sentiment.
3. Is a sideways channel bullish or bearish?
A sideways channel is considered neutral or consolidative rather than specifically bullish or bearish. It indicates a period of indecision in the market where buyers and sellers are relatively balanced, resulting in a range-bound price movement without a clear directional bias.
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