Many people who trade options towards the last week of expiry have been excited by the volatility this month – coming after nearly a year of relatively sane trading. Options have high implied volatilities and the daily moves in the Nifty are even higher, of the order of 2% (translation: options haven’t really priced in the moves), which makes the option values look great.
As I write this, the Nifty is at 4870 and the Nifty 4900 call, expiring on Thursday, is at Rs. 48. This means the nifty can move just 2% up from here, and you’ll end up profitable. With a month that’s seen us down over 12% this month, you might expect some sort of a recovery in the last few days.
But note that option prices on the Nifty carry at least a 6 point risk of STT. That is, if you hold till expiry, you’re going to pay Rs. 6 as Securities Transaction Tax on the trade. Towards the last day, options quote at about Rs. 6 less than intrinsic value because of this issue. I’ve made a more detailed video at MarketVision:
Also, commissions are quite high. Most brokerages charge you Rs. 30 to Rs. 50 per lot. A lot of Nifty is sized at 50, so a two-way trade (buy/sell) involves a cost of Rs. 100 per lot on brokerage or subsequent service tax, stamp duty, etc. which could add up to Rs. 150 per lot – that is, for a lot of 50, Rs. 3 per Nifty.
If you’re buying something at Rs. 48, and your costs are Rs. 3 for brokerage+, and Rs. 6 for STT, your breakeven point is Rs. 57 – or nearly 20% higher. You have to keep this in mind when trading options; if you don’t see a ridiculous gain (100%!) you shouldn’t trade the last few days – costs are high.
(A friend runs a brokerage called Zerodha – Disclosure: I’m an advisor – where I trade options – it costs me Rs. 20 per trade, and if I buy 200 Nifty options, my round trip cost on brokerage is very cheap – just Rs. 50 overall or Rs. 0.25 per Nifty. STT still applies, but I hardly even hold long options in the last week, unless the costs are accounted for)
Options are a great trading tool if you understand that it’s a very high risk bet as well. In the context of highly priced options, it may be better if, rather than buying, you WROTE strangles or straddles today, for the August expiry; this has the added advantage of the STT loss being priced in by Wednesday and gives you that much of a cushion. As always, there is a huge risk in being short options as well.