Trading — The tortoise strategy
Prerequisites — Basics of stock market, understanding of call and put options
Capital Required — 5–10 lakhs (20% active & 80% as backup)
Expected Returns — 2–5% per month (on active capital)
So you have ventured into the stock markets and while you are attracted by the shiny returns, you are also extremely risk-averse. You know only 1% of active traders make money in the stock markets, and you know many who have lost their hard earned money in this vicious black-hole.
What if I told you, there is a relatively safer way to participate in this hot area! If you’re excited, let’s get right to it.
So you have done your fundamental analysis and you have identified a stock you want to invest in. For this article we’ll take SBILIFE as an example (it’s my favorite stock and has the highest weightage in my portfolio). As of this writing the last traded price of SBILIFE is 982.55. The default way to invest here would be to buy equity shares of the company and sell them when the price rises.
If you are a believer of buying low and selling high, you would want to wait for the price to come down before you would be comfortable investing in it. Let’s say, you are comfortable with buying the stock at 900 a piece. This article is all about making money while you are waiting for the stock price to fall. And if it never falls? Then you continue to wait and continue to make money!!
How to achieve this you ask? Well, you sell something called the PUT option for this share at the strike price of 900. For the month of July that would be “SBILIFE JUL 900 PE”. When you sell 1 unit of this option (and hold it till expiry), it means you promise to buy 1 share of SBILIFE @ Rs. 900 if and only if the price of SBILIFE is below 900 at the end of trading session on last Thursday of July. In simple words, it’s betting that SBILIFE will not close below 900 by the end of the coming month. As of this writing, the lowest price of SBILIFE JUL 900 PE was Rs. 6 per unit in the last trading session. The margin requirement (price you have to pay upfront) for selling 1 lot (750 units) of these options is 1.4 lakhs. If things work in our favour that translates into a profit of 750 units × Rs. 6 = Rs. 4500. That’s 3.2% in a month!! ~40% returns in a year.
When will I profit?
If SBILIFE closes above 900 on the last Thursday of July. You will receive the margin that was blocked (1.4 lakhs) + the option premium (4500)
What if SBILIFE closes below 900?
That’s where your backup capital comes into play. Selling a put option is essentially being part of a contract where you have promised to buy 750 shares of SBILIFE @ Rs. 900 each, if and only if SBILIFE closes below 900. So you’ll need to take delivery of 750 shares, and you’ll have to pay 900 × 750 = 6.75 lakhs. Remember this article mentions having a backup capital which is nearly 4x of what you used as margin for selling the PUT option.
Ok, I have taken the delivery, what should I do now?
Remember you believe in buying it cheap and selling it high. Given that SBILIFE is a blue chip stock and also part of NIFTY 50, it is likely to bounce back, at which point you would like to sell the shares and book the profits. But hey, waiting is boring right? So, we’ll once again make money while waiting and sell the CALL option at the immediate next strike price from our buy price. In this case that would be 910. So we’ll sell SBILIFE JUL 910 CE, and continue to enjoy an additional premium at no extra cost. Of course the assumption here is that you bought a stock which was fundamentally strong, was likely blue chip and has minimal chances of going bust. Another thing to be mindful of is to only ever use the money which you are comfortable to invest and never trade with borrowed money.