Stock Options - An edge in a slow market?

[mike]

Because Bank Nifty options have changed from weekly expiries to monthly expiries, it may be harder for traders to find opportunities. However, options on stocks still continue to trade at a monthly cadence, I wanted to explore a bit and see how this market is performing.

This is data from last Friday (14 Feb). I’m listing the Nifty (for 2 expiries), Bank Nifty, and Top 15 companies that have the most liquid stock options. I’m defining liquidity as a small bid-ask spread (see “Spread” column). I’ve also listed the underlying LTP, ATM strike, minimum lot size, call bid price, call ask price, and cost to enter into this contract at the ask.

As you can see, these stock options are comparably liquid to the nearest expiries of the options on the major indices. In addition to this, the stock option cost is comparable or lower to the index options.

Of course, a lot of traders want to trade closer to expiry – whether it is due to the lower entry cost, potential for higher ROI, or increased volatility. The drawback of stock options is that margin costs increase during the week of expiry. As we saw previously, when it is 2 weeks from expiry, the entry cost of stock options is generally less than the entry cost of index options. But what if you compare stock options 2 weeks out (or less) vs. index options that are during the week of expiry?

I modeled this using the Black-Scholes formula. If you compare the top 10 stocks trading 2 weeks until expiry, the entry cost – assuming the stock’s minimum lot size – is comparable to the Nifty and Bank Nifty on Monday prior to expiry. This is seen in the column ‘Entry Cost’. I’ve also added a modeled ‘Loss’ column. This assumes that the underlying moves 1% against you on the day that you are holding this contract. The loss for the index options is higher, both in terms of amount and percentage of cost, than for the stock options. This is because of the larger impact of time value as you approach expiry.

Would be interested to know your thoughts on this. Has anyone added stock options to their portfolio of strategies in the last couple of months?

[athma_prathisti]

I want to use options for scalping but what i observed in some stocks is that it doesn’t move as quickly as the underlying stock, should we just rely on delta and gamma and IV for selecting these options. what will be your suggestion.
Probably an analysis of options for nifty and stocks with BSM in advance and then validate in the market if that option really moved fast as per your analysis and then add that BSM logic in the SDK ?

Reduce leverage in Intraday and increased margin in future people are trading in options, hopefully with above analysis you will help us in selecting the correct options while doing scalping.

[mike]

Hi @athma_prathisti -
Great questions. One of the things that I noticed is that stock option liquidity isn’t as “linear” as with index options. For the Nifty and Bank Nifty, you will see great liquidity at-the-money and as you go further in/out of the money, liquidity decreases. In addition, the non-even strikes will have less liquidity than the neighboring even strikes.

With stocks, you will want to have an idea of what the best strikes will be for the upcoming day. So, I agree…doing an analysis ahead of time will be helpful. IMO, IV and delta are likely good metrics to start with. But this assumes that the strikes you are considering are some of the most liquid for that underlying. You don’t want a perceived opportunity to be due strictly to limited trading activity.

I figured that there could be some more questions, and we are in the process of crafting an UpLearn webinar on trading stock options. I’ve reviewed the course content and there are some good ideas and metrics look at that will be discussed. I’ll post again once that course is ready to go.