The

Simplified
Futures and Options
Trading Strategy

By
Avinash Khilnani

Copyright @ 2013 Avinash Khilnani

1. INTRODUCTION: OF MICE AND MEN

2. DERIVATIVE PRODUCTS
Futures
Options
Call options
Call option as a bet
Put Options
Put Option as a bet

3. OPTION PRICING WORKSHEET

The Black-Scholes Model

4. THE SIMPLIFIED TRADING STRATEGY

The Contrary Positions Rule (CPR)
The advent of a bullish scenario
The advent of a bearish scenario
The Exit Rule
The Three Acts Play Summarized

5. WALK THE TALK

The Month of April-2012
The Month of May-2012
The Month of June-2012
The Month of July-2012
The Month of August-2012
The Month of September -2012
The First Half Results
The Month of October – 2012
The Month of November – 2012
The Month of December – 2012
The Month of January – 2013
The Month of February – 2013
The Month of March – 2013
The Second Half Results

6. IN CONCLUSION: OUTSMARTING MICE

There is a very easy way to return from a casino with a small fortune: go there with a large one.
- Jack Yelton.
1. Introduction: of Mice and Men
Is the human mind programmed to look for patterns, even when there are
none, or to miss seeing patterns even when these are obvious?

If the financial market is like a casino, ruled by chance, there would not be
any patterns to look for. If however, the whims of market players do
influence the price movements of stocks, commodities, currencies or market
indices, there is perhaps a chance that a trader may look for profitable
patterns in apparently random movements.

But then, the human mind also seems incapable of understanding chance. The
notion of a gambler’s fallacy illustrates this candidly. If one flips a coin a
billion times, the chance of getting a head is half a billion times while the
chance of getting a tail is also half a billion times. Thinking along these lines,
one might believe that after getting seven tails in a row, the chance of getting
a head is higher on the eighth flip.

Well, it’s not. The chance of getting a head on the next flip is still a half, even
if the tails appeared for a million times!

This fallacy arises because the human mind tends to replace the law of
chance with the so-called law of averages, which is actually a fallacious
inference from the theory of probability, usually called Bernoulli’s theorem.
The French mathematician, Simeon Poisson, made the theorem popular by
renaming it as the Law of Large Numbers.

Yet this muddleheaded idea, misnamed the law of averages, as a

misinterpretation of the probability theorem, underlies all gambling systems.
There can not be a system to improve one’s chances of winning in a game of
chance. That’s exactly why it is called a game of chance and is also the
reason that the casino always makes money while the gambler loses money
consistently in trying to outsmart chance.
Not too long ago, behavioral scientists’ experiments with mice yielded
interesting results. The experiment involved flashing green and red lights at
random, but the green light flashed 75 percent of the time. The mice were
rewarded with food if they guessed correctly what light will flash next. In a
matter of time, the mice could infer that the green light would flash more than
the red light, and so seeing a pattern in randomness, they simply guessed
green every time. The mice were rewarded 75 percent of the time and were
quite happy with their results.

Not so with humans. We, being the ‘smarter’ species, would impose our
patterns on the randomness and guess that since the green has flashed a
number of times, the next light to go on should be red. Humans guessed right
only 60 percent of the time. The gambler’s fallacy worked to our
disadvantage, and actually demonstrated that mice are far better decision
makers than us humans.

The human mind has a peculiar characteristic of fooling us into thinking that
we can control chance, and insists on imposing patterns on reality that are not
there, or worse still missing patterns that are there.

As if that’s not enough, most of us have this optimism bias that instills
wishful thinking into our behaviors, leading us on to make bad economic
decisions. The same bias also makes us loss-averse and stops us from getting
out of obviously risky ventures.

On top of that, our financial market with all its complexity, having evolved as
an information system with its own intelligence, has worked to force us to
impose order into chaos and to lead us further away from looking for
patterns. In an effort to not miss any such patterns, market players have been
trying various chart analysis tools to identify them.

Patterns are easily discernible on a chart and a cursory glance at the modified
Heikin Ashi chart will immediately reveal the ongoing trend in a market
index, stock, currency or commodity price movement. Coupled with the
golden ratio of a Fibonacci sequence, trend patterns and changes in trends are
readily observable. I have outlined the construction of the chart and triggers
based on the Fibonacci ratio in an earlier book titled “The Modified Heikin
Ashi Fibonacci Trading System” and the current book on trading strategy is a
natural extension of that trading style.

Trading the modified Heikin Ashi charts, we could see that although half of
the trades turned out to be winners and other half losers, the profits on the
winners were almost twice as large as the losses on the losers. Thus, we did
manage to play the game the way mice did in the green-red-light experiment
by acting consistently over time and winning 75 percent of the time, since our
winning actions yielded more money than the losing actions gave away.

In trying not to outsmart observable patterns, we behaved as rationally as the

mice did and stayed in the game. After all, we do have the same number of
active genes in our genome as the mice do, about 30,000 in all. So men and
mice are much alike in that sense.

But how about outsmarting mice?

Since we are also quite vain about us being the smartest of all species on
earth, we have designed highly complex financial markets and its
complicated financial tools. For a long time now, we have been using these
financial instruments as hedging tools to offset losses when trading patterns
change. And they do change, rather frequently and randomly.

This book is about demonstrating the use of derivatives tools known as

Futures and Options effectively in two ways:

1. initially, about getting on the right side of market by identifying and

trading the observable trend pattern in price movements, and
2. Subsequently, to realize that patterns can change randomly so an
appropriate strategy is to be inculcated into the trading style to not just
offset any loss by an imminent change in pattern but to actually
increase profit potential from such a change, should it occur.

I may stress here that the trading style demonstrates results empirically in that
what has happened in the past does not in any way guarantee what will
happen in the future. You should use the suggested strategy as per your own
discretion and are solely responsible for your actions resulting in profits or
losses. You are buying this book on the understanding that neither the author
nor publisher is engaged in any professional service or advice by publishing
this book. You should seek the services of a competent finance professional
to ensure that a situation is evaluated appropriately. The author and publisher
disclaim any liability, loss or risk resulting directly or indirectly from the
application of any content in this book.

With that evil but necessary disclaimer in place, let’s move on to what trading
in Futures and Option is all about.

Now, in order to employ these tools as a necessary part of your trading

actions, you must be familiar with trading futures and options. So, the next
chapter is on the basics of Futures and Options trading to introduce these
derivative products.

If you are already well versed in their use and understand the concepts of
option pricing, price decay with time and implied volatility, you may skip the
following chapter.

However, the subsequent section on option pricing may come in handy for
you in that you may create a simple enough worksheet to calculate option
prices, implied volatility and the Delta. You are then led on to a simplified
trading strategy that is devised to overcome the inherent human mind
characteristics of imposing patterns when there are none and also to make
redundant the dreaded optimism bias so typical of human traits.
The strategy predicts a maximum profit potential at the beginning of each
action and also gives reversal points in trading patterns with simple
mathematical formulae which you can easily embed as a worksheet in the
already existing spreadsheet that you created from the last book in this
sequel.

To ingrain the strategy successfully in your trading psyche, you might need to
work through a couple of months on index futures like the Dow Jones
Industrial Average Futures. The most popularly traded Dow Jones futures
are:

1. the E-mini Dow Futures that have a multiplier of $5 (ticker symbol

 YM on the CME Globex), and
2. the DJIA Dow Futures that have a multiplier of $10. (ticker symbol
ZD)

There are also the Big Dow futures with a multiplier of $25, and ticker
symbol DD.

The book then suggests a clear and well defined strategy of playing the
futures against options. So you should be familiar with index options as well.
If you are playing the Dow futures, you need to understand the corresponding
Dow options.

For the Dow Jones index, we have the DJX options that are of a European
style and so can be effectively set against the E-mini ($5) Dow or the DJIA
($10) Dow futures. The S&P 500 options have their counterpart European
style options as SPX, if you want to play the SPX futures that are based on
this index.

You need to make sure that the options you sell with this strategy are
European styled, since American type options have this bothersome aspect of
being exercised against you if these options happen to become in-the-money.

The book then walks you through twelve months of trading the S&P CNX
Nifty so that you can trade any other index, stock, currency or commodity
that has actively traded futures and options on any other exchange. I have
taken a ‘real world’ trading example in Nifty since the option contracts in this
index are European styled with monthly expirations, and the historical data of
both futures and options is freely and publicly available, so that you can
verify the option prices. The DJX or SPX historical data may not be freely
accessible except perhaps through your brokerage trading platform.

I continue that walk for the ongoing present month, demonstrating the
strategy of playing the E-mini Dow futures against the DJX options
(European styled) through the web pages at niftytracker.com.

As you patiently walk along with me through trading the futures and options
combinations, you would soon affirm a trading style in your psyche as an
optimum technique to play index futures against index options.

That trading psyche is an attempt to outsmart mice, and so the concluding

chapter is a debate on who turns out to be smarter: men or mice.
If you want to make God laugh, tell him your plans.
– Woody Allen
2. Derivative Products
Derivative products are called so because they are derived from the
underlying index or stock or commodity or currency prices. The most
actively traded derivatives are Futures and Options.
Futures

Let's start from the basics, assuming you are new to derivatives trading. You
might skip this section if you are familiar with and are already trading futures
and options.

Consider the Dow futures as a derivative product of the index known as the
Dow Jones Industrial Average or US 30 that is dependent on the actual value
of spot DJIA.

You cannot trade the spot or the actual DJIA, which is a weighted aggregate
of thirty very liquid stocks, but you can trade its futures. The price of the
Dow futures may be higher (at a premium) or lower (at a discount) than the
spot (actual) value of US 30, depending on the perception of traders. For
example, if E-mini Dow futures are being traded higher by about 50-100
points than the spot Dow, the market players expect the Dow to close higher
than the current value by expiry day, the final settlement date.

Now, unlike stocks, which you must have in your trading account in order to
place a SELL order, futures can either be sold or bought, according to your
view of the market.

So, if you believe a market index like the DJIA (or share price of a particular
stock, like Google) will fall, you can execute a SELL order in its Futures
(even if you do not have Google shares in your account). If the actual value
of index or stock price does fall, you will make a profit by buying back the
Futures you had sold, which will be the difference between the price at which
you had sold the futures and the price at which you have now bought back the
sold position in your derivatives portfolio. When you buy back the Futures,
your derivatives position will be squared off and the sell position will no
longer show in your portfolio.

Likewise, if you think the stock price (or an index like the US 30 or S&P
500), is about to rise, you will execute BUY to create an open position of
long futures of that stock or index, in your trading account. To square off,
simply sell the Futures, and if the value of the underlying stock or index has
indeed risen, you have made good money.

You can square off your derivatives positions any time you want to, within a
second of creating the position or the next hour, or on any other day till the
expiry day of the Futures' delivery month.

Leveraged Trading

Futures trading has this advantage that you only need to have some margin
money in your account to be able to execute high volume trades because of
the leverage available in such trades. Margin is the amount of cash a trader
must have as collateral to support a futures or options contract. Margin
requirement are based on risk analysis algorithms and can vary from time to
time, and from exchange to exchange worldwide.

Index futures have a multiplier that inflates the value of the contract and so
this is called leveraged trading. For the DJIA, this multiplier is 10. The E-
Mini Dow futures have a multiplier of 5. The S&P has a multiplier of 250
and for the NASDAQ it is 100.

This is leveraged trading, i.e. with a little cash; you are leveraging your trades
to much higher volumes. Of course, both your profits and losses are
magnified to that extent. So, for example, if the Dow futures are trading at
14,000 and if you bought one futures contract, it would be worth $140,000. If
the Dow went up by just one point, this would mean a $10 profit in real terms
for you, and in mark-to-market terms, would be settled daily until you close
out the position by selling the contract or the exchange does that for you on
the expiry date. If the index fell by 100 points, this would imply a loss of
$1,000 since you were long on the Dow.

Derivatives Expire

Futures as derivatives products of a certain delivery month are set to expire

on a scheduled date during that month, and are denoted as such. The Dow,
S&P, NASDAQ and other index based futures have quarterly cycle delivery
months like Mar, June, September and December.
The Dow-Jun13 contracts would expire on June 20, 2013 while the Nasdaq-
Jun13 would expire on June 19, 2013. The expiration date is usually the third
Friday of delivery month.

The FTSE 100 futures contracts would also expire on the third Friday of
delivery month, but the Nifty futures on the NSE, India usually expire on the
last trading Thursday of that month, unless the day happens to be a trading
holiday, in which case an earlier or later day may be selected by the
exchange. The Nifty futures, in contrast to the Dow and other indices, have
monthly delivery months. So, if you have open position in futures which you
have not squared off, the exchange will compulsorily close out (square off)
the position at the closing of the expiry day. The loss or profit will be
adjusted to your account according to the closing price of the expiry day.

Futures are thus derivatives contracts between the seller and buyer and are
actively traded as contracts named after the delivery month. These are then
known as, for example, YMZ13 (Dec 13 contracts for the E-Mini Dow), or
DOW-Jun13, or SP-Sep13 etc. You can initiate trades on any of these, though
Mar-14 futures may not be as liquid (or as actively traded) as June-13 or Sep-
13 futures.

With this background on Futures contracts, let’s move on to the other

derivative instruments called the Options, which are a pretty handy tool for
hedging risks involved in trading futures or stocks.
Options

Another class of derivative products is the options. These can be 'call' or 'put'
options.

Call options

A call option is the right to buy a certain property at an agreed price before a
certain date, by paying a premium. The premium is like a signing amount or
advance you would give to the property seller, promising to come back
before the agreed date (which is the expiry date) with rest of the asset's value
to acquire the asset.

Setting aside the basic definition, note that in the F & O market, since
European styled options (like the DJX and SPX) are cash settled, you don't
have to actually acquire the asset. If the value of the asset (in our case the
index Dow or S&P 500 or Nifty, or share price of a stock) went up and you
had bought a call option on it, you would be paid the profits made on the
option at expiry, or if you decide to square off (sell) the option on any other
day prior to the expiry date, you would rake in the profit on that day. You
don't have to wait till the contract’s expiry.

Options too have a multiplier that inflates the value of an option contract, and
so an option trading is also leveraged to the extent of the multiplier.

The Dow index options have a multiplier of 100. So, if you are buying the
DJX call options for a price of say, $2.95, the premium that you need to pay
to hold the option is $295.00. The S&P 500 and NASDAQ 100 options also
have a multiplier of 100. The S&P CNX Nifty options have a multiplier of
50. It’s very important to look at the multiplier because that is what decides
the size of the contract, also called the lot size.

It is also important to check if the options are American or European styled.

Always prefer playing the European style options because these can not be
exercised against you if the underlying index goes above the strike value of
the call option, or in the case of a put option, if the underlying index falls
below the put option strike.

It is worth noting here that the E-Mini Dow options (YM) are American
style, as are all the ETF based options. So, if you are playing the E-Mini
Dow, remember to offset these against an equal number of Dow units by
selling the DJX options which are European styled.

A general notation for the DJX option can be as below:

DJX Nov 2013 153.000 call, or

DJX131116C00153000.

This is a call option for DJX that is based on the underlying index of Dow
Jones, and is set to expire in the month of November 2013, after 16th of
November. The call option is for the strike of 153, being 1/100 of the Dow
Jones index of 15,300.

A corresponding put option would have a notation like:

DJX Nov 2013 153.000 put, or

DJX131116P00153000.

But more on the put options later in that section.

Call option as a bet

A call option, then, is a contract or a bet taken on the stock price or index
value. There is a seller (also called the ‘writer’ of the option) and a buyer
(also called the ‘holder of the option). Take an actual example of the S&P
CNX Nifty call options of strike 5400. Let's make a bet on the Nifty that the
index would reach beyond 5400 by the expiry date of 26-April-2012. In this
case, 5400 is our 'Strike' price; the option is this month's call option is labeled
as 'Nifty -April-5400-CE’.

The table below lists the actual call option prices, with the last column
showing the value of the underlying which in this case is the Nifty 50. This
historical data has been sourced from the publicly accessible nseindia.com
archives.

NIFTY-
CE APR-26-2012 Strike: 5400
Underlying
Date Open High Low LTP Settle Price Value
30-Mar-
12 64.4 91.5 59.1 82.75 87.95 5295.55
2-Apr-
12 80 90.7 73 82.4 80.5 5317.9
3-Apr-
12 90 98.55 83 88.65 89.1 5358.5
4-Apr-
12 79 79 63.5 72.2 70.8 5322.9
9-Apr-
12 44.65 53.1 34.95 36.5 36.8 5234.4
10-Apr-
12 38 40.1 29.8 36 36.95 5243.6
11-Apr-
12 27 40.65 22.9 35.5 31.7 5226.85
12-Apr-
12 36.1 44.5 33.35 36 38.65 5276.85
13-Apr-
12 44 46.5 15.25 18.8 21.5 5207.45
16-Apr-
12 15.05 24.8 14 23.5 22.9 5226.2
17-Apr-
12 18 35 16.15 29.85 30.3 5289.7
18-Apr-
12 35.5 40.1 21.7 22.45 25.65 5300
19-Apr-
12 28.9 33.8 21.05 33 30.15 5332.4
20-Apr-
12 25.5 26 6.8 12 12.75 5290.85
23-Apr-
12 10 11.75 1.8 1.9 2.35 5200.6
24-Apr-
12 1.9 2.5 1 1.25 1.3 5222.65
25-Apr-
12 1 1 0.25 0.3 0.3 5202
26-Apr-
12 0.1 0.15 0.05 0.05 0 5189
 Table 1
(Source: nseindia.com)

I may decide to sell (or, write) the option, believing that Nifty would not go
beyond 5400 by the close of expiry date. And if you decide to buy the option,
hoping that the index would reach much higher than 5400, our agreed strike
price, you are going long on the option. We agree on a bet price of, say 86,
near the closing price on 30-Mar-12. The value of the underlying NIFTY on
this date is around 5295. You, as the buyer would pay me this amount (the
premium), and I would get the cash in my account the same day.

If Nifty does indeed reach beyond 5400 to, say, 5500, I would have to pay
you the difference in strike price (5400) and the actual value of Nifty (5500,
in our hypothetical scenario) which is 100 units in cash. So you would have
made a profit of 14 units (you had paid 86 units earlier), and I would have
taken a loss of 14 units, I lost the bet on the strike price of 5400.

You would lose the bet, on the other hand, if Nifty could not reach beyond
5400, with your position of BUY in this option returning nothing. You would
lose the entire premium you paid me. In this scenario, you can see that you
would not actually make any money unless Nifty crosses 5486, which would
serve as the breakeven point for your position. Only if the underlying crosses
this breakeven point, would you make any profit from your bet.

A value of 5401 at the expiry date would yield you just a unit, and that would
mean a loss of 85 for you, and a profit of 86 for me.

As the buyer (or holder) of the call option, your maximum loss can only be
the amount you paid me as the seller (or writer) of the option, while your
maximum profit potential is unlimited since the index may rise to
unprecedented levels.

For the writer of the option, the maximum profit is just the amount received
at the time of selling the option, but the maximum loss potential is unlimited
as the index can rise indefinitely.
This strike example was an out-of-the-money (OTM) strike price, since on
the day we entered into a contract; the underlying asset was at 5295 while the
strike price selected was 5400. There are various strikes available on Nifty, so
5300 would be called 'at-the-money' (or ATM) option and 5200 as the 'in-the-
money' (or ITM) option; the underlying is already above 5200.

As you ponder over the table above, notice that the value of the option price
seems to depend on the underlying asset. As the Nifty falls, so does the price
of the option. However, during the initial couple of days when the Nifty does
rise a bit to a level of 5358 and 5322 on the 3rd and 4th of April, the option
price does not seem to rise in tandem.

And in fact, when the underlying is at 5332 again on the 19th April, the option
price has actually taken a beating at being quoted around an average price of
just 31 units, although the underlying value is higher than the day on which
you bought the call options.

Apparently, there is more to option pricing than just the underlying. The
option price, being a contract value between the seller and the buyer, is also
dependent on the number of days left to expiry since it has an expiry date and
also an initial perception of the market view held by the market players built
in, which is reflected as ‘implied volatility’.

So, initially, the option price was rather high on 30th Mar, since the days left
to expiry were more, and the expectations of the market players of the Nifty
being bullish led to their willingness to pay higher price for the call option.
This factor alone resulted in higher implied volatility for the option.

Thus, the option price depends largely on:

1. the underlying value,

2. the number of days left to expiry, and
3. the implied volatility (IV).

With time, IV is generally expected to decline as the number of days to

expiry decrease, and even with the underlying gradually rising, the option
price may not rise in step because now the market players may not be willing
to pay too high a premium on the option. So, for a corresponding rise in the
underlying, the rise in the option price may not be as much as it was initially.
This sensitivity of the option price to the underlying is measured as the
‘delta’, denoted as the Greek letter ∆.

This is the most important Greek in option price calculation and along with
IV is going to play a critical role in your exit plan strategy.

In trading derivatives, you need to appreciate that writing options is the best
option for you, since you have two very important friends on your side:
Implied Volatility and TIME. Both these allies on your side will work to
reduce the option price as the expiry date approaches, resulting in an
effortless profit for you if the market does not move, or moves very little.

Another ally for you is the trend with whom you are already familiar, and you
are soon going to have these folks on your side with the simplest trading
strategy explained in this book.

But before that you need to understand the complementary to call options:

Put Options

These are the other options in the derivatives segment. The exact opposite of
a call option, the put option holder has the right to sell a certain property at an
agreed price before a certain date, by paying a premium.

Setting aside the basic definition because in the F & O market and noting
again those as options are cash settled for European styled options, you don't
have to actually hand over the asset. If the value of the asset (in our case the
index Nifty, or share price of a stock) went down by the expiry date and you
had bought a put option on it, you would be paid the profits made on the
option at expiry, or if you decide to square off (sell) the option on any day
before the expiry date, you would rake in the profits on that day. You don't
have to wait till expiry.

A put option, then, is a contract or a bet taken on the stock price or index
value between the seller (the writer of the option) and a buyer. The contract
size, or the lot size, of a put options is also dependent on the multiplier. Put
options would have the same multiplier as the call options for that same
particular index or stock.

Put Option as a bet

Take an example of the Nifty. Let's make a bet on Nifty that it would fall
below 5100 by the expiry date of 26-April-2012. In this case, 5100 is our
'Strike' price, the option is this month's put option labeled as 'Nifty-April-
5100-PE’.

I decide to sell (or, write) the option, believing that Nifty would not fall
below 5100 by the close of expiry date. And you decide to buy the option,
hoping that the index would drop much below 5100, our agreed strike price.
We agree on a bet price of, say 49 units on 30-Mar-2012. You, as the buyer
would pay me this amount (the premium), and I get the cash in my account
the same day.

NIFTY-
PE APR-26-2012 Strike: 5100
Settlement Underlying
Date Open High Low LTP Price Value
30-Mar-
12 81.5 81.65 45 50.45 48.15 5295.55
2-Apr-
12 52.1 52.85 31.15 32 34 5317.9
3-Apr-
12 29.4 29.4 21.4 23.8 24.1 5358.5
4-Apr-
12 29.4 31.75 27.1 27.5 29.65 5322.9
9-Apr-
12 35 46.4 32.6 44.95 43.85 5234.4
10-Apr-
12 40 50.35 34.85 37 37.5 5243.6
11-Apr-
12 44 53.5 29.3 38.3 42.25 5226.85
12-Apr-
12 38.9 38.9 26.3 28.95 28.25 5276.85
13-Apr-
12 30 51.2 18.5 45.2 43.75 5207.45
 16-Apr-
12 51.9 51.9 28.05 28.95 31.65 5226.2
17-Apr-
12 36.9 37.7 10.7 11.25 12.1 5289.7
18-Apr-
12 10.8 10.8 7 8.6 8.5 5300
19-Apr-
12 7.3 7.75 3.55 3.6 4 5332.4
20-Apr-
12 4.15 16 3.1 5.6 6.45 5290.85
23-Apr-
12 6 17 2.65 17 14.65 5200.6
24-Apr-
12 7.8 15 4.95 5.3 6.1 5222.65
25-Apr-
12 3.85 16.9 2.9 3.55 3.8 5202
26-Apr-
12 1.1 1.1 0.05 0.05 0 5189

Table 2
(Source: nseindia.com)

If Nifty does indeed crash below 5100 to, say, 5000, I would have to pay you
the difference in strike (5100) and the actual value of Nifty (5000) which is
100 units in cash. So you made a profit of 51 (you had paid 49 earlier), and I
took a loss of 51.

On the other hand, if Nifty did not fall to below 5100, your position of BUY
in this option returns nothing, and you lose the premium you paid me. So you
would not actually make money unless Nifty dips below 5051, which serves
as your breakeven point.
A value of 5099 at the expiry date would yield you just one unit to you, and
that would mean a loss of 48 for you, and a profit of 48 for me.

This strike example was an out-of-the-money strike price for put options.
There are various strikes available on Nifty, so 5100 would be called 'at-the-
money' option and 5400 as the ‘in-the-money' put option because the index
was already below this strike price on 30th March 2012.

As the buyer (or holder) of the put option, your maximum loss can only be
the amount you paid me, the seller (or writer) of the option, while your
maximum profit potential is unlimited since the index may fall to pre-historic
levels.

For the writer of the option, the maximum profit is just the amount received
at the time of selling the put option, but the maximum loss potential is
unlimited as the index can fall back to its base level or even below that.

Contemplating on the table above, you can see that as the Nifty value
underlying the put option begun rising initially, the put option price declined
along with every rise in the index. This shows that put options have a
negative Delta in contrast to call options which have positive Delta.

However, as the index fell back the price of the put option begun rising until
the 13th April, when it was quoting at 43 for the underlying at 5207. So,
although the Nifty has indeed dropped some 90 points since you bought the
options, the option price is somewhat below what you paid me on 30th March.

The time factor has obviously worked against your BUY position in the put
option. The Greek Delta too has not been kind to the option price. As the
index rises and falls back to 5200 on the 23rd April with only 3 days left to
expiry, the option price has dropped even further. The expiry day sees the
Nifty close at 5189, which is still above the strike price, resulting in the
exchange closing out your position returning nothing.

The Put option has expired worthless for you as the holder of option, while I
get to keep all the money I received as the writer of the option.

The pricing of the put option, as with the call option, also depends on
underlying value of the index or stock, the number of days left to the expiry
date and the perception of the market players reflected as implied volatility.

Option pricing also depends slightly on a number of other factors like

dividend yield and the general interest rate. The next chapter explains a
popular option pricing model which you can use to estimate option prices and
to calculate implied volatility along with Delta.
After a certain point, money is meaningless. It ceases to be the goal. The game is what counts.
– Aristotle
3. Option Pricing Worksheet
Now that most of the options traded are the European type, you may apply
the Black-Scholes model to calculate option price, implied volatility and
Delta.

The European type option cannot be exercised against you if you are the
writer of the option, which simply means that the holder of the option cannot
force you to pay up in case the option is making you a loss. You can, of
course, square off the option at will, and so can the holder at any time on or
before the expiry of the contract.

In the American type of options, the holder of the option also has the right to
exercise and if such a request comes in from the holder, the exchange can
then randomly force any writer to close out the position at a loss.

The model below that is used to calculate option prices works for the
European style of options and since you will be writing just these types of
options, this should work very conveniently for your purposes.
The Black-Scholes Model

These two gentlemen came up with a rather complex formula to estimate IV

given the option price. Without going into the detailed mathematical
explanations, which would be rather cumbersome and quite un-necessary for
our purposes here, let’s get down to actually creating a worksheet for the
model.

The inputs or parameters involved in their formula are:

1. the Spot price of the underlying, which is the stock price or index.
2. the Strike price of the option.
3. the number of days left to expiry; this is to be converted into year units.
4. the Implied Volatility, which can be estimated by the model given a
value of the option price.
5. the risk-free interest rate, specific to your country or region, and
6. the dividend rate, which could be an aggregate guess for the stocks in
an index, or a specific stock’s dividend rate if you are estimating that
stock’s option prices.

In your working spreadsheet for the modified Heikin Ashi Fibonacci triggers,
you may insert a worksheet and name this new worksheet as ‘Option
Pricing’.

Now, in column A and B, and through rows 1 to 6, type in the column

headings and row parameters as shown below:

A B
1 Parameters Value
2 Spot Price 5295.55
3 Strike Price 5100
4 Expiry in Days 27
Implied
5 Volatility 0.19200
Risk free
6 Interest 0.09
7 Dividend Rate 0.21
In this example, the column B contains the values of the parameters as the
input data. I have shown the values for the 5100-PE from Table-2 for 30th
March 2012.

Next, you need to calculate the four factors as given by the Black Scholes
model in the next four rows, denoted as d1, d2, nd1 and nd2. But before these
four factors, please convert the time to expiry from days to years by dividing
the number of days with 365, in cell B9.

Leaving row 8 blank as a separator between the inputs and calculations, you
have the next five rows too and your worksheet now looks as follows:

A B
1 Parameters Value
2 Spot Price 5295.55
3 Strike Price 5100
4 Expiry in Days 27
5 Implied Volatility 0.19200
6 Risk free Interest 0.09
7 Dividend Rate 0.21
8
*(type in
9 Expiry in Years formula)
*(type in
10 d1 formula)
*(type in
11 d2 formula)
*(type in
12 nd1 formula)
*(type in
13 nd2 formula)

Since cells B9 to B13 contain formulae, you might color these cells
differently, and protect the cells so that you do not inadvertently overwrite
the formulae.

Type in the formula “=B4/365” in cell B9, to convert the number of days into
the year format.
The cell B10 contains the formula for d1, which is calculated by putting in
the formula:

“=IF (ISBLANK(B7), LN(B2/B3)+((B6+(0.5*(B5^2)))*B9), LN(B2/B3)+

((B6-B7 + (0.5*(B5^2)))*B9)) / (B5*B9^0.5)”

This may seem intimidating, (notice the Excel notations for exponentials,
natural logarithms, and square roots – enough of mathematics to spoil your
breakfast) but if you typed in all the right letters and symbols, and you are
getting the value 0.57666 in cell B10 with the inputs exactly as seen in the
worksheet so far, you know you have got it right.

Cell B11 for calculating d2 is easy enough to type in. The formula is “=B10-
B5*B9^0.5”.

Next in queue are the standard normal distributions nd1 and nd2. The MS-
Excel already contains the function for standard normal distribution
calculation to do that, so all you need is to type in the two cells B12 and B13
the formulae : “=NORMSDIST(B10)” and “=NORMSDIST(B11)”
respectively.

(I will not venture into explaining what standard normal distribution

functions or exponentials and natural or base 10 logarithms mean here, or
why they are here at all. That would make a separate booklet in itself. Suffice
it to say that the model works as a pretty good approximation of option prices
and implied volatility).

If you have done everything right so far, the formulae in cells B9 to B13
would be returning the following figures:

A B
Expiry in Years 0.07397
d1 0.57666
d2 0.52444
nd1 0.71791
nd2 0.70001
If this seems right for you, you may proceed to calculate the option prices in
columns D and E, leaving column C as a separator.

Type in the parameter for column D as shown in the table representing your
worksheet here:
 A B C D E
1 Parameters Value
*(type in
2 Spot Price 5295.55 CE price formula)
*(type in
3 Strike Price 5100 CE Delta formula)
4 Expiry in Days 27
Implied
5 Volatility 0.19200
Risk free *(type in
6 Interest 0.09 PE price formula)
*(type in
7 Dividend Rate 0.21 PE Delta formula)
8
9 Expiry in Years 0.07397
10 d1 0.57666
11 d2 0.52444
12 nd1 0.71791
13 nd2 0.70001

The column E contains the formulae for option prices and Deltas so you
might color these cells differently from the input cells, and also lock the cells
after typing in the formulae so that these are not erased accidentally later.

Now the call option price is calculated by typing in the formula at cell E2 as:

“=IF(ISBLANK(B7),B2*B12-(B3*EXP(-B6*B9))*B12, EXP(-B7 * B9) *

(B2 * B12) - (B3 * EXP(-B6 * B9) * B13))”

The Greek Delta for the call option is yielded by the formula given below in
cell E3:

“= B12*EXP(-B7 * B9)”

The rows numbered 6 and 7 in column E contain the formulae for put option
prices and Deltas, and the put option price is calculated by typing in the
formula at cell E6 as:
“=IF(ISBLANK(B7),EXP(-B6*B9)*B3*(1 - B13) - B2 * (1 - B12),EXP(-B6
* B9) * B3 * NORMSDIST(-B11) - EXP(-B7 * B9) * B2 * NORMSDIST(-
B10))”

The Greek Delta for the put option is yielded by the formula given below in
cell E7:

“= (B12 - 1) * EXP(-B7 * B9)”

Now compare your results with the table below, and if the figures match
perfectly, you have the Black Scholes option pricing model right there for
you in your very own spreadsheet!
 A B C D E
1 Parameters Value
2 Spot Price 5295.55 CE price 196.77
3 Strike Price 5100 CE Delta 0.707
4 Expiry in Days 27
Implied
5 Volatility 0.19200
Risk free
6 Interest 0.09 PE price 49.01
7 Dividend Rate 0.21 PE Delta -0.278
8
9 Expiry in Years 0.07397
10 d1 0.57666
11 d2 0.52444
12 nd1 0.71791
13 nd2 0.70001

You may now tweak the input values by typing in other figures for IV or
number of days to see how the Put option price varies. Notice how the price
and delta changes with days left to expiry. Play around and get a feel of the
option price changes with IV, spot price of underlying and days to expiry.

While you may not write anything in the cells for option prices or the Deltas,
since these contain formulae that are derived from the inputs in cells B2 to
B7, you can use the ‘Goal Seek’ function available in the MS-Excel
worksheet under the ‘Tools’ section.

As an example, if you see the price of a call option of strike 5100 being
quoted at say, 190, and the spot value of the underlying at 5290, with 24 days
left to expiry, you can change the relevant inputs in cells B2 to B7, and then
use the ‘Goal Seek’. In the box that appears on selecting the ‘Goal Seek’ tool,
set cell: E2, To value: 190 ( CE value) By changing cell: B5.

The worksheet would then perform a number of iterations to return a value of

Implied Volatility in cell B5. To help the worksheet along, you may have to
type in a reasonably feasible value of IV in B5. If you have an absurd value
of IV there, the goal seeking tool may return nothing.
Alternatively, you may type in various values of IV in cell B5 yourself until
the desired call option value is seen in cell E2. The Delta for the call option
will then be calculated along with the CE value.

You may also familiarize yourself with checking IV and Delta for various
strikes and other call and put options prices being quoted on different days of
the month.

Since you would be writing (selling) options, it’s important to get a handle on
IV and Delta. For the call options, an IV of greater than 21 % (0.21) is good
enough to sell as higher IV means you are getting a good amount of money
for this, while an IV of 13% or more is great for selling put options.
Sometimes, you may not see such IVs but may have to go along anyway.
Also, these thresholds are strictly sacrosanct. With more exposure to writing
options over a course of time, you might arrive at your own thresholds that
work for you with other indices or stocks.

The Greek symbol Delta is sensitive to the underlying asset’s price and when
you see this more than 0.9, it may be time to square off positions and book
profits or losses as the case may be. For put options, this would be a negative
quantity in notation, but the same rule applies. With a Delta of 0.9 and
approaching 1, usually during the last 8 days of a contract’s life, you may
take home more than 80 percent of the maximum profits promised by the
combination of the futures and options strategy that is explained in the next
chapter.

There are other Greeks that I may mention here only for information
purposes:

1. Vega is the one that is sensitive to volatility, and

2. Theta is rather touchy about the time factor, and
3. Rho shows the change that responds to interest rate.

For our purposes, we are quite content with the Delta as a guide to exiting
positions. Vega and Theta are anyway redundant to us since we are directly
incorporating the values of IV and time in our trading behavior.
The Black-Scholes equation primarily estimates the price of an option over
time and Delta-hedging is its prominent handle to profit from hedging
opportunities. In reality, being perfect in what it is, it is actually our equations
that are only an approximate representation of that reality. There are many
ideal assumptions in formulating any mathematical picture of reality and we
have to bear with those imperfections as long as our purpose in selection of
hedges is achieved satisfactorily.

Keeping this in mind, let’s put the Futures and Options trading strategy in
place.
I made a fortune getting out too soon.
-John Pierpont Morgan
4. The Simplified Trading Strategy
As you look at the MHAF chart, you might notice either a bullish trend
already in progress or an ongoing bearish trend. Your trading skill dictates
that you take a new position only at the start of a trend, bullish or bearish.

And when you take a fresh position, the basic rule you must follow is the
Contrary Positions Rule as below:
The Contrary Positions Rule (CPR)

For every position created in futures, create an equal and opposite (contrary)
position in options for the current calendar month contracts. Since we are
writing options, and want the options to expire in the month, in order to profit
from time decay and falling implied volatility, the calendar month should be
the same as the delivery month, or in any case, the expiry day should not be
more than 34 days away from the day you are creating new positions. The
expiry day should also be not less than 13 days from the day you are
executing a new strategy.

Thus, if you have gone long in futures, which is a bullish position, go short in
the nearest (higher than the futures price) out-of-the-money call options,
being a contrary bearish position; or, if you have gone short in futures
(bearish scenario), also go short in the nearest out-of-the-money ( lower than
the futures price) put options ( which is a bullish position).

Make sure that the number of lots in futures and options are such that
quantity-wise, the positions are equal. As an example, the DJIA ($10) Dow
Futures have a multiplier of 10, so buying one lot of Dow Futures has 10
Dows as its lot size, but the DJX (1/100) call options has a multiplier of 100,
which makes it one unit of DOW index. To make the positions equal, you
would be buying 1 lot of Dow futures and selling against it 10 lots of DJX
call options.

The Nifty futures and options size has the same multiplier of 50; hence 1 lot
of Nifty futures equals 1 lot of Nifty options.

So, as you create positions in Futures and Options, pay attention to the
multiplier for each that decides the lot size. In the example below, we will
consider the lot size to be equal for both futures and options, to make
understanding easier.

Each action at the start of a trend should then comprise of creating contrary
positions. Furthermore, if the trend changes from bullish to bearish or from
bearish to bullish, the same CPR applies.
Now, let’s see how this simple rule manifests into your derivatives trading
portfolio in the two possible initial scenarios.

The advent of a bullish scenario

At the beginning of a bullish trend, you would create BUY position with one
lot of futures, as a long position, and also simultaneously create one lot of
SELL position of the nearest OTM call options. This combination is known
as a covered call, only here the calls have covered by futures instead of
stocks.

To calculate the maximum profit potential (let’s abbreviate this as MP from

now on for brevity) from such a position, assume that you bought the futures
at a price of F1 and sold call options of strike CS at a premium of CP1, you
might use this simple math:

MP = (CS – F1 + CP1)

This is the maximum profit you can hope to get, even if the index or stock
price goes on to the moon or above. The CPR has effectively limited your
profit potential to this level and worked to inhibit greed besides robbing you
of your optimism bias. The nearest sky is the limit for now.

Continue to hold on to the positions as long as the trend continues, and book
profits when the option’s Delta approaches the value of 0.81 to almost 1. This
will yield most of the estimated maximum profit, if not all, in your trading
account.

Although the sky, in this case the strike price and above, is the limit to
maximum profits, remember that the sky is vulnerable. Quite like Chief
Vitalstatistix of the Gauls in those Astrerix Adventure comics, you have only
one thing to fear: that the sky may fall on your head tomorrow.

So if the trend does not remain bullish for long, and the sky does fall
tomorrow or on any other day, you have to pay attention to the breakeven
(BE) point. This can easily be calculated as below:

BE = F1 – CP1

In the event that this breakeven point is violated, you would need to change
the positions accordingly. So this point will now also serve as the reversal
point (RV) for your positions from bullish to bearish.

Hence, RV = BE = F1- CP1

In such a scenario, you had long futures and short call options initially but as
the reversal point is breached, you would be selling futures and selling OTM
put options. This action squares off your long futures leaving you with nil
positions in futures, and short OTM call and put options, which is called a
short strangle.

To profit from the imminent bearish scenario, you must now also have short
futures, so sell futures again, this time to have short futures in your trading
account, and again, compelled by the CPR, also sell another lot of OTM put
options simultaneously.

The combined action at the Reversal Point is then actually selling two lots of
futures, at a price of say, F2, and also selling two lots of Put Options at a
price of say, PP1 and of a strike say, PS.

Now, with the first reversal in trend, you have the following three positions in
your derivatives trading portfolio:

1. One lot of short OTM call options;

2. One lot of short futures; and
3. Two lots of short OTM put options;

You can now revise the maximum profit potential and break-even or reversal
points. The calculations for these are now a bit more complex. Once you
know the maximum profit levels and reversal points, you can prepare to
either book profits when the put option’s delta exceeds -0.55, or if the
maximum profit strike level is reached during the last 13 days of expiry date
or reverse positions prior to that if a reversal point is hit.

The maximum profit potential on the downside (MPd) is now calculated in

two steps as follow:

1. Loss on squaring off futures = L1=(F2 - F1) ( a negative quantity)

2. MPd = (F2 – PS + 2*PP1 + CP1 + L1)

This maximum profit as an ideal objective would be available only if the

index closes at the put options strike of PS on the day of expiry.

To check the amount of profits you could make if the underlying index or
stock price closed at a price of say EX, on the day of expiry, you may replace
PS by EX in the above formula to get realizable profit at EX, as below:

Realizable Profit (RP) = (F2 – EX + 2*PP1 – 2*PP + CP1 + L1),

where EX is the spot value of the underlying as closing price on the day of
expiry, and
PP is given by (PS - EX) if EX is less than PS, but is nil if EX is equal to or
more than PS.

PP appears because this is premium you would have to pay back in case the
underlying asset’s price falls below the put option’s strike price.

If the underlying asset’s price goes below the PS level, the profit potential
would drop since a certain amount of premium received on the written put
options would have to be paid back. In fact, if the underlying falls a lot, the
situation may even turn up a loss, since you have two lots of put options sold,
against one lot of short futures. So, there should be a breakeven point
somewhere below the strike price level.

This breakeven point on the downside (BEd) can be simply calculated as

below:

BEd = PS - MPd

In a scenario when the underlying has taken this BE level rather rapidly and
there are still some days left to expiry, you would have no choice but to
square off all positions because trying to cover the extra one lot of short put
options by selling more futures or continuing the strategy any further would
only add to the chaos. Any such further action at this point might only
increase losses or decrease available profits depending on the number of days
left to expiry and the resultant implied volatility. The best way out is stay
alert to the delta value -0.55 on the put options you have sold and square off
all positions once you see this delta level. This is because only 50 percent of
the put options are covered by the short futures and a delta beyond this level
would decrease available profits. So, keep an option delta of -0.55 as the
optimum level to exit all positions.

However, you might try and shift strikes of both call and put options
downwards, keeping the futures as they are. Just make sure that the next
lower put option delta is less than -0.34. Depending on the premiums
available, you can recalculate the exit point on the downside and the reversal
point on the upside. If these points are comfortably away, you can consider
shifting downwards.

Alternatively, you may also sell one more lot of futures and at the same time,
sell an equal one lot of put options, at the OTM put strike if this strike is
reached very quickly by the spot index . This would bring the ratio of futures
to options at 2:3, instead of the previous 1:2. This action will result in
shifting the exit point a bit further away, and reduce the possible loss from
the position, while increasing the profit potential. With this new ratio of
futures to options, you can stay in the game until you see a delta of -0.67 for
the put options.

Try and re-calculate the maximum profit potential, the exit point and the
reversal point for this scenario from the new futures price and option
premiums. That should be simple enough for you by now.

But get out while you can, with perhaps just a small loss if you see the BEd
being breached, or shift strikes downwards if the premiums on the options
show workable limits on the upside and downside breakeven points.

Again, a good exit plan would be to square off all positions and book
whatever available profit (or a small loss) is left on the downside when there
are less than 13 days left to expiry and the underlying index or stock price is
near the maximum profit level of the put option strike.

To calculate Realizable Profit on any other day prior to the expiry day, you
would have to subtract the premiums to be paid when you square off :

If the price of futures where you square off is F, the premium paid back on
the call options is CP and the premium paid back on the put options is PP,
then :

RP = (F2 – F + 2*PP1 – 2*PP + CP1 - CP + L1),

So, remain alert to the possibility of exiting during the final 13 days of expiry
when you can book about 80 percent of MPd or when the Delta for put
options is seen from -0.80 to -1. Remember to check the Option pricing
model for the Delta value and IV regularly.

On the upside, since you now have one lot of short futures, a reverse situation
on the upside too can result in a breakeven or reversal point. If the underlying
begins to rise, you would profit from the short put options, but would begin
taking a loss from the short futures until a point where the loss from the
future is more than the premium received on the written put and call options.

This breakeven point on the upside (BEu) is easy enough to calculate as

given below:

BEu = PS + MPd

Notice that there are now two breakeven points where you may have to take
action and one maximum profit potential level where you may square off the
entire portfolio.

Continuing our upside scenario further, if the upside reversal point is

breached, you must buy back the short futures at a price of say F3, and by the
CPR dictation, you must also sell an equal lot of the same OTM strike call
options that exists in your portfolio, at a price say CP2. Again, for the now
bullish scenario, you have to buy futures to create a long position in futures,
and simultaneously also sell an equal amount of call options.

So, at the upside reversal point, BEu, you would actually be buying two lots
of futures at a price of say, F3 and selling two lots of call options at a
premium of say, CP2.

You would then have the following open positions in your trading account:

1. Three lots of short OTM call options;

2. One lot of long futures;
3. Two lots of short OTM put options.

The calculations for maximum profit potential levels and reversal points are
now slightly more complex but still involve these two steps:

1. L2 = F2 – F3 ( a negative quantity)
2. MPu = (CS – F3 + 2*PP1 + CP1 + 2*CP2 + L1 +L2)

Now, the breakeven point on the upside can again be simply calculated as:

BEu = 0.5*MPu + CS , (half of the Max Profit since futures to call options
are now 1:3)
while the breakeven point on the downside is :

BEd = CS – Mpu.

Again, this maximum profit potential is only achievable under the ideal
condition that the index or stock underlying price closes at CS on the day of
expiry. So, if you can realize 80 percent of this maximum profit or if you see
the call option delta nearing 0.55, you may square off all positions to bank
your profits. Although only one third of the call options are now covered by
the futures, you can still keep positions until a higher level delta of 0.55,
since you also have 2 lots of put options sold to make up the loss for that
extra bit of higher delta.

In case the call option’s OTM strike is reached very quickly by the spot
index, you might buy one lot of futures, to bring the ratio of futures to options
to 2:3 from the earlier 1:3, if this seems feasible when the amount of
premium is rather high on the options. This action will help raise the upside
breakeven point a little higher so you would have more days for the strategy
to work in your favor. It will also enable you to hold to a higher value of
delta of 0.67. You must now be able to calculate fresh maximum profit
potential and the exit points both on the upside and downside, and remain
alert to to the possibility of these new figures being hit anytime.

The exit plan now should entail squaring off all positions in any one of the
following conditions:

1. About 80 percent of MP is realizable, or

2. The Delta of relevant option is nearing 0.55, or
3. The maximum profit potential level near the relevant strike price is
seen when there are less than 13 days left to expiry.
4. Any one of the breakeven points MPu or MPd on the upside or
downside is breached, and shifting strikes downwards, or altering the
futures to options ratio, or reversing positions upwards is not feasible.

So far, you have acted three times during the same calendar month’s
contracts. The fourth action should always be to square off all positions if a
further breakeven point is breached. Take whatever profit or loss has accrued
and wait for the next month’s contract to start afresh.

Now, just to clarify the trading strategy further, consider the alternative initial
scenario of a bearish trend, that is, if the modified Heikin Ashi chart (MHAF)
triggers suggest a bearish scenario at the start of a calendar month.

The advent of a bearish scenario

The first action in this case would be to sell one lot of futures and to sell one
lot of OTM put options. Having calculated the breakeven or the reversal point
and maximum profit potential, you would wait until more than 80 percent of
the maximum profit is available to square off or change the portfolio in case
the reversal point is breached.
If the reversal point on the upside is violated, you may square off the short
position in futures by buying the futures, and as per the CPR guidance, also
sell an equal lot of OTM call options. To take advantage of the now bullish
scene, you may buy one lot of futures and also simultaneously sell one lot of
the same OTM call options.

With this second leg of positions creation, you now have the following in
your derivatives portfolio:

1. One lot of short OTM put options;

2. One lot of long futures; and
3. Two lots of short OTM call options.

You can now calculate the maximum profit potentials and breakeven point on
the upside and the reversal point on the downside. I will not burden you with
more formulae here since these would be quite similar to the ones above with
an obvious deviation for the now complementary situation.

The formulae will appear simpler as you walk through the twelve months of
actually trading the Nifty in the next chapter.

Remain alert to the possibility of squaring off all positions if more than 80
percent of the maximum profit potential is available at any time of the day, or
if the call option’s delta hits 0.55, or the maximum profit potential level is hit
when there are less than 13 days left to the contracts’ expiry, or if the
breakeven point on the upside is hit pretty soon.

If, however, a reversal point is breached on the downside, you would reverse
the futures from BUY position to SELL position, by selling once to square
off the long position and selling one lot again to create a short position.
Simultaneously, you would also sell two lots of the same OTM strike put
options.

With this third action, you would now have the following open positions:

1. Three lots of short OTM put options;

 2. One lot of short futures; and
3. Two lots of short OTM call options.

(Remember that since the ratio of futures to put options sold is 1:3, the exit
point on the downside is calculated by subtracting half of the MPP from the
put option’s strike).

Now that three creative actions to be taken are exhausted, the only remaining
fourth action would be to square off all positions as per the Exit Rule, unless
shifting strikes on the downside appears feasible depending on the next exit
and reversal points that can be re-calculated with the available premiums on
the new strikes, or increasing the ratio of futures to options appears feasible.

I know this may seem a bit daunting at first, but be assured that once you take
the actual trading walk in the next chapter; the whole strategy would seem
like a walk in the park.

Let’s now formulate the second rule of this simplified trading strategy:
The Exit Rule

A. Square off all positions if more than 80 percent of maximum profit

potential can be booked on any day of the contracts’ month, or if the Delta of
the relevant option is nearing 1 from 0.8.

B. Square off all positions if the breakeven point is breached from the second
leg of trading action, or if the option delta hits 0.55 ( or -0.55 in case of the
covered put options).

C. Square off all positions if reversal point is breached for the third time. The
fourth leg of action is always getting rid of all open positions.

D. Square off at the maximum profit potential levels if the level is seen at any
time during the last 12 days of the contracts’ life, i.e. when less than 13 days
are left to expiry.

These rules will also be pretty obvious to you as you go through a real-life
example next, so don’t be intimidated by these for now.
The Three Acts Play Summarized

Act I: The curtain raiser is creating contrary positions in futures and options,
either with a bullish or bearish view.

Act II: The derivatives trading drama is carried out to the climax of either
reaching the maximum potential profit level of 80 percent or of taking actions
at reversal points. Only two reversal actions are permitted, just like in a play
where a crisis and a disaster situation emerge at different places in the second
act while the third act usually offers a solution.

Act III: Curtains are dropped by squaring off all positions if either maximum
profit potential level is hit during the last 13 days of contracts’ lives ( a happy
ending), or relevant delta is breached, or a third reversal point (a tragic end) is
hit.

With these Three Acts of the trading play outlined and rehearsed well, let’s
see how the drama unfolds for the next twelve months by walking the talk in
actually trading the S&P CNX Nifty.
Concentrate your energies, your thoughts and your capital. The wise man puts all his eggs in one
basket and watches the basket. –Andrew Carnegie.
5. Walk the Talk
The S&P CNX NIFTY is a basket of the 50 most actively stocks on the NSE,
India. Let’s watch that basket through the past twelve months. Since the lot
size of Nifty futures and options is the same, i.e. having the same multiplier,
and the delivery cycle is monthly with every calendar month having the same
delivery month contracts, this index is ideally suited to serve as an example
of the CPR F&O strategy.
The Month of April-2012

It is rather important that you initiate contracts for the month when a fresh
trend, either bullish or bearish, has just begun for the month, and this is
perhaps the only time that you will look at the modified Heikin Ashi chart
(MHAF) triggers already created by you as a spreadsheet from the earlier
book titled “The Modified Heikin Ashi Fibonacci Trading System”.

I will reproduce here the triggers as calculated from that spreadsheet:

Date NIFTY Buy StLoss Sell StLoss

21-
Mar 5267.2 5372.35 5256 5364.95
22-
Mar 5361.1 5385.95 5205.65 5228.45
23-
Mar 5255.65 5312 5220 5278.2
26-
Mar 5274.35 5274.95 5174.9 5184.25
27-
Mar 5242.95 5277.95 5184.65 5243.15 5303 5231 5207 5279
28-
Mar 5231.7 5236.55 5169.6 5194.75 5302 5238 5214 5278
29-
Mar 5145.95 5194.3 5135.95 5178.85 5289 5228 5204 5265
30-
Mar 5206.6 5307.1 5203.65 5295.55 5237 5162 5138 5213
2-
Apr 5296.35 5331.55 5278.8 5317.9 5250 5192 5168 5226
3-
Apr 5353.2 5378.75 5344.45 5358.5 5270 5218 5194 5246
 4- 5328.65 5338.4 5305.3 5322.9 5334 5282 5258 5310
Apr
9-
Apr 5282.5 5287.9 5228 5234.4 5371 5309 5285 5347
10-
Apr 5254.1 5255.8 5211.85 5243.6 5342 5286 5262 5318
11-
Apr 5209.45 5263.65 5190.8 5226.85 5324 5259 5235 5300
12-
Apr 5246.75 5290.6 5246.75 5276.85 5284 5229 5205 5260
13-
Apr 5255.7 5306.75 5185.4 5207.45 5317 5235 5211 5293
16-
Apr 5190.6 5233.5 5183.5 5226.2 5300 5242 5218 5276
17-
Apr 5266.6 5298.2 5208.35 5289.7 5276 5205 5181 5252
18-
Apr 5320.7 5342 5293.45 5300 5267 5210 5186 5243
19-
Apr 5320.6 5342.45 5291.3 5332.4 5300 5242 5218 5276
20-
Apr 5313.95 5336.15 5245.45 5290.85 5343 5271 5247 5318
23-
Apr 5277.40 5310.55 5187.15 5200.60 5361 5278 5254 5336
24-
Apr 5215.90 5232.35 5180.35 5222.65 5327 5268 5244 5302
25-
Apr 5222.20 5236.10 5160.65 5202.00 5306 5240 5216 5282
26-
Apr 5214.75 5215.60 5179.05 5189.00 5276 5222 5199 5252
27-
Apr 5189.00 5223.05 5154.30 5190.60 5266 5202 5178 5242

Table 3

The MHAF chart for that time is shown here for your reference:
The bullish candle and trigger on 30-Mar becomes the starting point for your
trading strategy. Since you are buying futures and also selling call options
simultaneously, it would not matter much if you executed the trades when the
past one hour’s average price crossed the bullish trigger of 5237, or waited
until nearly closing time. This is because if you bought the futures at a lower
price during the day, you would be receiving less premium on the call options
when the underlying was not as high as at closing time and vice versa if you
bought the futures at a higher price near closing time, you would be receiving
higher premium on the call options then.

It’s always prudent to wait until near closing time in this case, say about 10-
15 minutes before the closing bell since by that time you are apt to avoid the
volatility of the day and the price discovery mechanism is already over,
confirming the advent of the bullish trend.

As the Nifty closes near 5295, the bullish trend wants you to buy Nifty
futures, and presuming we are buying near the close, we now have an open
position in Nifty as below:

BUY Nifty-Futures-26-Apr-2012 at 5327.

(Let’s presume here that you bought somewhere between the closing and the
last traded price – LTP). You may retrieve the historical values of both
futures and options from the derivatives archives available at nseindia.com.
Here are the tables for the prices of futures and options that you would need
to refer to during this trading walk for the month of April:
 NIFTY Futures APR-26-2012
Underlying
Date Open High Low Close LTP Value
30-Mar-
12 5,246.00 5,346.90 5,239.00 5,333.25 5,322.00 5,295.55
2-Apr-
12 5,300.00 5,372.00 5,300.00 5,350.65 5,357.75 5,317.90
3-Apr-
12 5,377.00 5,402.00 5,367.80 5,383.25 5,383.10 5,358.50
4-Apr-
12 5,361.00 5,361.00 5,324.75 5,344.55 5,349.05 5,322.90
9-Apr-
12 5,294.00 5,301.90 5,245.05 5,253.00 5,252.25 5,234.40
10-Apr-
12 5,261.15 5,277.50 5,226.00 5,266.15 5,264.40 5,243.60
11-Apr-
12 5,224.00 5,292.25 5,203.15 5,251.35 5,267.00 5,226.85
12-Apr-
12 5,274.70 5,308.40 5,260.00 5,290.65 5,283.10 5,276.85
13-Apr-
12 5,303.90 5,330.00 5,195.20 5,221.10 5,211.00 5,207.45
16-Apr-
12 5,188.90 5,258.00 5,182.00 5,248.45 5,257.00 5,226.20
17-Apr-
12 5,249.70 5,325.30 5,221.15 5,319.60 5,321.00 5,289.70
18-Apr-
12 5,347.00 5,364.45 5,312.25 5,322.70 5,315.00 5,300.00
19-Apr-
12 5,330.05 5,366.15 5,312.85 5,356.20 5,364.00 5,332.40
20-Apr-
12 5,310.00 5,353.55 5,000.00 5,302.00 5,304.80 5,290.85
23-Apr-
12 5,297.00 5,314.65 5,182.25 5,198.60 5,184.00 5,200.60
24-Apr-
12 5,199.80 5,238.90 5,186.20 5,224.35 5,229.65 5,222.65
25-Apr-
12 5,220.00 5,235.40 5,153.40 5,198.60 5,196.50 5,202.00
26-Apr-
12 5,221.15 5,221.15 5,174.95 5,186.65 5,189.20 5,189.00

Table 4

Now, as long as the Nifty continues to rise, you would make profits setting
your target price for Nifty near the initial resistance that Nifty may face on its
uptrend as seen from your MHAF trigger table (not shown above).

If you have bought a single lot, comprising of 50 futures, and the Nifty
reached 5484 as a supposed target level, you stand to make a profit of 157*50
= (5484-5327)*50 i.e. 7850 units per lot.

But what if Nifty takes a downturn tomorrow, and decides to pursue a bearish
target of instead? After all, the market has an uncanny sense of knowing what
trade you have taken, and doing quite the opposite!

Not trusting the market, and in order to save your face (and money), you
might also take a contrary position along with your bullish position. So to
create a short position in Nifty, consider selling Call Options. Since the
nearest OTM strike relative to the futures price of 5327 is 5400, you might
sell Nifty calls of strike 5400 which would give you 84 points per lot. Notice
that adding this premium value to the strike price of the call option gives the
figure of 5484 which is very close to a reasonable resistance level proposed
by your spreadsheet.

You can see this premium was available at the time from Table 1 shown in
the section on ‘Call option as a bet’ in chapter 2.

Somehow, other market players have already sensed this to be a highly

probable target as they are willing to pay you this premium already.

Now, you have two open positions in your portfolio that are contrary to each
other, because if the Nifty does reach 5484, you stand to make a profit of
7850 on the long futures, and lose no points on the call options, since you
would have to pay back 84 units on these options for which you had received
84 units. So, the net profit you would make if Nifty closes at 5484 by expiry
date, (26-April-2012) is 157 units.

Fair enough, if Nifty does indeed do that.

You may calculate the maximum profit you could make with these open
positions using the formula:
MP = (CE strike-futures price) + premiums received on CE
= (5400-5327) + 84
= 73+84
= 157.

How much you would make if the Nifty stays at the level where you bought
the futures, i.e. the spot value of the Nifty closes at 5327 on the close of the
expiry day?
Easy enough to estimate that you will not make any money on the futures but
get to keep all the money on the call option sold, so that’s still a profit of 84
units, even if the index does not move.

Let’s now calculate the break even point, where you do not make any money.

This would be simply the price where you bought the futures minus the
premium you received for selling the call options. The break-even point can
be found as below:

BE point = Futures price – premium received

= 5327 -84
= 5243.

This seems to be a very important figure for your open position, and should
serve as a reversal point. If you do see this value of 5243 being quoted for the
Nifty spot, you should be reversing your futures position from BUY to SELL.

You now have two critical values for the Nifty spot to look out for:

1. The target value of 5484 or above and when the Delta for the call
options is nearly 1 is where you can hope to get the maximum profit,
and
2. The reversal value of 5243, where you would reverse your portfolio.

With this reversal point established, you no longer need to look at the MHAF
chart or stop-loss figures to reverse your positions. The F & O market has
decided the reversal point for your positions.
The next trading day, 2nd April shows the Nifty to be within these two values
and so you let your positions be as they are. The 3rd and 4th April also keeps
you in the position, being well within the limits set by your estimates above.

The 9th of April finally spurs you into action as the Nifty dips below your exit
value of 5243 towards the close of the day. Now, you might square off the
Nifty futures by selling the lot you had bought.

The selling price for the futures near the closing is 5252 and this has turned
into a loss of 75 points for you (5252-5327). If you were to now also square
off your sell position in call options by buying back the options at a premium
of 36, you stand to gain 48 points here. So, by exiting both your positions at
the Nifty spot of 5235, you have actually taken a loss of only 27 points on the
combo.

However, following the Contrary Positions Rule, you would be selling

futures twice, once for squaring off the earlier BUY position, and then selling
again to create a SELL position in futures.

This would imply that you should sell two lots of Put Options of target strike
of 5100, since the CPR rule wants you to create a contrary sell position in put
options for every lot of futures sold. You are choosing a strike that is a little
further away from the futures price since you are selling two lots of put
options. This results in a breakeven point on the downside that is comfortably
away.

If you did, you just received a premium of 44 on each lot, giving you 88
points in all.
(Refer to Table 2 in the section on ‘Put Option as a bet’ of chapter 2 to see
the put options premiums).

What is the maximum profit that you now hope to achieve with these
positions?
Note that you now have the following open positions:

SELL 50 Nifty-Futues-April-2012 at 5252

SELL 50 Nifty-CE-5400-CE at 84
SELL 100 Nifty-PE-5100-PE at 44

So, the maximum profit for you would now accrue at the strike value of
5100, as follows:

MPd = (F2 – PS + 2*PP1 + CP1 + L1)

= 5252-5100 + 2*44 + 84 -75,

= 152+88+84-75,
= 249.

Isn’t this even better than the earlier combo that had promised you a
maximum profit 157 units at the start of a bull trend?!

Could the mice anticipate that?

Going through the motions of the calculations again for this combination, you
note that if the Nifty closes at the spot value of 5252 where you had sold your
futures, you would still make a profit of 97 ( premiums received on put and
call options, minus the loss already taken on the long futures). Compare this
to the initial combo where you would have taken of profit of 84 units, if the
Nifty had stayed at the value of futures bought price.

You are now actually in a slightly advantageous position because the Nifty
moved contrary to your expectations!

Next, you may calculate the breakeven and reversal points in case Nifty
decides to move away from your positions. There are now two breakeven
points because you have a short strangle created on the options.

On the downside, you will be taking maximum profits at the put strike value
and then decreasing profits since there are two lots of put options sold. You
can calculate that on the downside, the profit from your peculiar combination
will decrease linearly to a zero at Nifty spot of 4851, and turn to an
increasing loss thereafter.

This figure can easily be calculated by subtracting the maximum profit

available at the put strike from the strike itself, or as already shown in the
section on ‘Advent of Bullish Scenario’ of the previous chapter :

BEd = PS – MPd

Thus, on the downside, the profits would shrink to null at a value given by
(5100-249) that is 4851.

The critical breakeven figure for this combination now stands at 4851 on the
downside when you would have to reluctantly square off all positions and
take a small loss.

Since you also have a short call option position on the upside, you would
have to check the spot value of Nifty that would turn this combination into a
loss, and where you might reverse your open position in futures.

The critical reversal figure for this combination on the upside stands at 5349,
after which the combination begins to make increasing losses. Again this can
be calculated simply by adding the maximum available profit of 249 to the
strike value of 5100 which returns the maximum profit. Thus, reversal point
on the upside comes to:

BEu = PS + MPd

= 5100+249

= 5349.

As it turned out, these two critical values were never hit by the spot close of
Nifty on any day during the life of the contracts, and the Nifty closed at 5189
on the expiry date of 26-April-2012.

Using the Realizable Profits formula, you can calculate the total profit
achieved by replacing the put strike value PS by the closing value of Nifty on
the expiry day.

Realized Profit (RP) is calculated as:

RP = (F2 – EX + 2*PP1 – 2*PP + CP1 + L1),
where EX is the spot value of Nifty as closing price, and
PP is the premium to be paid back if the underlying asset’s price fall below
the strike price of PS, but is nil if the underlying asset’s price is equal to or
more than PS.

In this case of the month of April 2012,

RP = (5252 – 5189 + 2*44 – 2*0 +84 – 75)

= 160.

The CPR trading strategy shows a total profit of 160 points for all your open
positions combined at this closing value of 5189. Both the call and put
options expired worthless, good for you, as you got to keep all the money
received on the options, while taking a loss of 75 points on the long futures
and a profit of 63 points on the short futures.

Compare this profit obtained by the derivatives strategy to the simple trend
following plan of entering and exiting to reversing positions in plain futures.

Trend following the MHAF triggers through acting at buy, stop-loss and sell
triggers, you would have made 60 units of profits, taking six trades in all.
Three of these trades resulted in profits, while the rest three turned sour. This
would also have entailed entering and exiting trends at the right time of the
day and keeping yourself awake throughout those trading days.

Following your strategies by calculating reversal and breakeven points in

advance and simply acting near the close of the day not only gives you
greater profits but also saves you the stress of carefully watching the index all
day long.

Hasn’t life gotten much easier now?

The Month of May-2012

As the derivatives for the month of April expires on the 26th, you look
forward to the month of May. The downtrend on the modified Heikin Ashi
chart continues and so it is best to wait for the start of a fresh trend to enter
into a strategy for the new month.

Remember you are allowed only three actions in a month, so please do not
squander away one action by getting into an already going on trend.

Sure enough, on the 30th of April, the trigger on your spreadsheet for a bullish
trend appears, and so you create a long position in futures near the close of
the day, buying a single lot of futures at a price of 5268.

(Please appreciate that in order to not fill this book with too many tables and
charts, I will presume that you have your MHAF spreadsheet handy and can
see the chart and triggers to initiate trades. Also, the futures prices and option
prices are as accessible to you as to me at the historical prices section at
nseindia.com, so I need not make this section any heavier than it already is by
showing all those tables again for every month).

Again, not trusting the market too much, you also sell call options of an OTM
strike of 5400. You could also choose to sell the strike of 5300, but that
would be too near to the futures price and reduce your maximum profit
potential somewhat. As a thumb rule, try and keep the strike price at least 50
points away from the futures price at the time of initiating the trading
strategy.

Writing this CE of strike 5400 would give you 46 units in your account that
day.
(refer to the historical archives at nseindia.com if you need to verify this).

Now, Maximum available Profit = (5400-5268) +46,

= 178.

While the reversal point is calculated as:

=5268- 46, which is 5222.

Now, the stop-loss on the MHAF sheet reads 5178, which seems a more
comfortable exit point than the one dictated by selling 5400 CE options. But
this is a trailing stop-loss and you might expect this exit to approach the
reversal point suggested by the options strategy.

If you calculate the implied volatility for this strike and option price, you
would find that this IV is 19.95 percent which is somewhat low but may work
for the strategy.

The Maximum Profit is then fixed at 178, while the exit point for this
combination of covered calls strategy is at 5222.

So, armed with these critical values of target and exit points, you sit back
happily to watch the play of the markets.

The 3rd of May-2012 sees you waking up alert as the reversal point for your
open position is breached with Nifty dipping to 5188, prompting you to
reverse your positions.

You may now sell the existing long position in futures near the close of the
trading at 5203, taking a loss of 65 units, and sell another lot to create a short
position in Nifty futures at the same price.

To act contrarily to your selling two lots of futures, you also sell two lots of
put options for a strike of 5000 which is near to the short target of 4982 as
shown on your MHAF spreadsheet. Again this strike is also a little further off
since you are going to have twice the lot of short options on the downside
than the upside. You receive 38 units for a lot which is a sum of 76 units in
your trading account.

Using the formula for calculating Maximum Profit and the two breakeven
points on the upside and downside, you get:

Maximum Profit if Nifty closes at 5000 on the expiry day = 260, and

Exit point on the downside = 4740, while

Reversal point on the upside = 5260.
(Aren’t these pretty simple calculations now?)

As you keep monitoring the rise and fall of the Nifty, remain alert to these
critical values.
The extreme points were never hit by the index during the life of the open
positions in your trading account, and finally on the day of the expiry, the
Nifty closed at 4924.

You could have taken the available profits when the Nifty spot reached the
value of MPP level of 5000 during the last 13 days of contract’s life, but let’s
see what the combination reveals if you held on to the position until the
expiry day.

Putting this closing of the spot Nifty in your formula for Realizable Profit
calculations, you can see that you took a profit of 184 on the combination
strategy of a short strangle and mildly covering the downside with short
futures.

RP = (F2 – EX + 2*PP1 – 2* PP + CP1 + L1)

= (5203 – 4924 + 2*38 – 2*76 + 46 – 65)
= (5203 – 4924 + 76 – 152 + 46 – 65)
= 184.

Now, comparing this figure to the MHAF trading plan, you note that you
might have taken a profit of 236 with five trades, two of which had resulted
in small losses. Of course, this would have meant remaining alert throughout
the days of the month, and acting at or near the trigger points suggested by
your spreadsheet.

On the whole, so far, you have made more money with the derivatives
strategy for the two months than by following the MHAF simpler plan.

Let’s now see what the back testing reveals for the month of June-2012.

The Month of June-2012

The downtrend that begun on 31st May for the Nifty continues till the 5th of
June, so you patiently wait for a fresh trend to appear before creating new
positions in the index.

The 6th of June sees a powerful white candle and the trigger for a bullish trend
is breached, inspiring you to take a long position on Nifty futures at 4977
near the close of the day. The upside target or resistance suggested by the
spreadsheet being 5065 implies that you also write the call options strike
5100, taking in 55 units in your trading account.
You may also find out from your Option Pricing worksheet that the implied
volatility for this strike is 22.6 which is good enough to write.

Now, you can easily calculate that the maximum profit afforded to you is:

MP = (5100-4977) +55,
= 178.

The exit point, also the reversal point for this covered call combination
should then be:

Exit point = 4977-55

= 4922.

As you sit back, watching the ebb and flow of the market, the Nifty keeps
rising steadily and falling back on some days but never breaching your exit
point. Finally, with a close at 5149 on the expiry day of 28th June, that was
above the strike price of the call option, this single action resulting in the
simplest of a covered call yields you the maximum profit available which is
178 units.

Of course, you would be paying brokerages in your trading account as the

trading exchange bills you for closing out the in-the-money options, but for
our purpose here that is outlining trading strategies, we are neglecting this
part in order to not complicate calculations. (Brokerages are pretty small
these days, anyway).

Let’s now compare this result to the simple trading plan of following the
MHAF pattern.

For a total of six trades in this pattern, five turned out to be losers and only
one returned a profit, resulting in a net loss of 45 points for the month.

Well, your single covered call strategy came out quite on top this time.

The Month of July-2012

As you scan your MHAF spreadsheet, you notice that a bullish trend had
actually begun on 29th June, just a day after the expiry of June contracts on
28th June. Although the triggers seemed all right on 27th June, the closing
price was still around 5142, quite below the bullish trigger of 5155 on that
day.

Remember that for our back testing purposes, we shall presume that we are
letting the exchange close our open contracts expire on the date of expiry,
although you might have closed your position any time prior to 13 days of the
expiry date or any other day when you noticed the Delta nearing 1 from 0.8.

Also, following the simple trend following plan, we will compare the profits
or losses accrued with the same initial position for our derivative strategy.

Now, since a proper bullish trend ensued on 29th June, you should buy one lot
of Nifty futures contract for July at 5293 near the closing trades of the day,
and consider selling the call options for strike price of 5400 which was going
for a premium of 54 units.

Using the goal seeking tool on your Option Pricing worksheet, you estimate
the IV for this option at 0.208. The IV for the 5300 strike call option priced at
95 is around 0.224.
These are relatively high IVs, so you may consider selling any one of them.

However, since the strike of 5400 offers better maximum profits and a
reasonable reversal point, you may decide to go along with the 5400 CE. In
any case, you are actually happier at reversal points since they tend to
increase your profit potentials!

The critical values for maximum profit and the reversal point are then
calculated as:

MP = (5400-5293) + 54
= 161.
Reversal point, in case the trend turns bearish = 5293-54, i.e.
= 5239.

Now the 12th of July turns bearish as the as the spot Nifty closes near 5235,
quite below 5292, the trigger for selling the index, and just below 5239, the
reversal point, prompting you to square off the long futures at a price of
5249, taking a loss of 44 points on the futures.

As you sell the one lot of futures, you also take a contrary bullish position by
selling put options. Further, to profit from the ensuring bearish trend, you
may want to short futures and simultaneously sell put options as a contrary
position.

Checking the IV of the put options for strike 5100, you notice that the IV for
this put option priced around 20 is just 0.127 which is quite all right for
writing a put option. Although the bearish target on the MHAF spreadsheet
suggests the strike of 5000, you may find the premiums for this put strike to
be very low, so you decide to write the 5100 strike put options.

As you create a short position in Nifty futures at 5249, you also sell two lots
of put options of strike 5100 for a price of 20 units each.

Now, you have made a loss of 44 points on the long futures but still hold the
sell position in call options at 54 points, so you have not yet actually taken a
loss on your initial combination.

You can calculate that the maximum profit from this new combination stands
at 199 points if the Nifty closes at 5100 on the expiry day. Again, you are
relieved that your profit potential has actually gone up from the initial 161 to
199, simply because the index happened to disagree with your charts!
Further, you can calculate that on the upside your reversal point would be
5299 and on the downside, the breakeven or exit value exists at 4901.

As the Nifty moves over the next few days, there is some anxiety on 19th July
when you see a white candle on the charts, but the index did not breach the
reversal trigger of 5299 on the close of that day. Sure enough, over the next
days to the expiry date, the Nifty continued to be bearish and ended at 5043
on the closing bell of 26-July.

If you did not close out your open position in puts during the day, the
exchange and your broker house did, leaving you with a net profit of 142
points for the month.

You can see how this profit is realized from the Realizable Profit formula as
below:

RP = (F2 – EX + 2*PP1 – 2* PP + CP1 + L1)

= (5249 – 5043 + 2*20 – 2*57 + 54 – 44)
= 142.

Please note that this time PP has a value of 57 because the closing price of
Nifty went below the Put options’ strike price of 5100, and so you had to pay
back that difference on the short put options in your portfolio.

Upon following the simple trading plan as dictated by the MHAF

spreadsheet, you would have taken 6 trades, with three turning bad, but the
rest three still managing to create a net profit of 129 points for you, that is
still nearly equal but slightly less than the futures-options strategy.
The Month of August-2012

The 30th of July shows a clear bullish trend beginning with the closing price
at 5199 well above the buy trigger of 5131 on the Heikin Ashi Fibonacci
tables.

The futures are priced at 5215, so the nearest strike of 5300 is a logical target
to write the short calls. These are priced at 53 indicating an Implied Volatility
of 18.8 percent on the goal seeking scenario in the Option Pricing model.
Being below the threshold of 21 percent IV, one lot of the call options needs
to be sold to take a contrary position for the long futures.

Now, the maximum profit from this combination is (5300-5215) +53 which
comes to 138 points. The reversal or exit point is then 5162, which is as
always the futures price less the option premium received in a bullish
scenario.

Following the movement of Nifty over the next days, this reversal point was
never breached during the life of the futures contract.

Perhaps you were half hoping that the index would take a downward turn
soon enough, because the past few months have revealed that an opposite
movement gives more profits to you than a monotonous single trend.

Although, the bullish trend did reverse to a bearish scenario on the 27th of
August as observed strictly by the closing price during the entire month, your
reversal point of 5162 was never hit. You could have booked your profits
during the last expiry week of trading whenever you saw the Nifty hovering
above the profit target of 5353.

Even if you did not, and waited for the expiry day, you would still make a
profit of 138 points, as the Nifty closed at 5315.

Thus, you have made a net profit of 138 for this month of August -2012, with
only a single covered call strategy in your portfolio.

Comparing this to the trend following MHAF pattern, you note that the
strategy has again turned out better because the MHAF trading plan of a total
of four trades had actually turned up a loss of 23 points.

So far, humans have indeed been outsmarting mice!

The Month of September -2012

I suppose I must break the monotonous flow of text for the last 4 months of
trading. So here is the MHAF triggers table for the month of September.

Date NIFTY Buy StLoss Sell StLoss

31-
Aug 5298.20 5303.25 5238.90 5258.50 5388 5325 5300 5363
3-
Sep 5276.50 5295.80 5243.15 5253.75 5354 5295 5270 5329
4-
Sep 5249.15 5278.35 5233.20 5274.00 5336 5279 5255 5311
5-
Sep 5243.90 5259.50 5215.70 5225.70 5330 5275 5250 5306
6-
Sep 5217.65 5260.60 5217.65 5238.40 5305 5250 5226 5281
7-
Sep 5309.45 5347.15 5309.20 5342.10 5264 5210 5187 5240
8-
Sep 5343.65 5366.30 5343.45 5365.35 5298 5249 5225 5273
10-
Sep 5361.90 5375.45 5349.10 5358.15 5336 5286 5262 5312
11-
Sep 5336.10 5393.35 5332.10 5391.10 5366 5304 5280 5342
12-
Sep 5404.45 5435.55 5393.95 5432.80 5369 5314 5289 5345
13-
Sep 5435.20 5447.45 5421.85 5435.35 5399 5349 5324 5375
14-
Sep 5528.35 5586.65 5526.95 5567.40 5393 5332 5307 5369
17-
Sep 5631.75 5652.20 5585.15 5606.90 5460 5395 5371 5435
18-
Sep 5602.40 5620.55 5586.45 5599.85 5538 5484 5459 5513
20-
Sep 5536.95 5581.35 5534.90 5554.25 5597 5538 5513 5571
21-
Sep 5577.00 5720.00 5575.45 5691.15 5584 5492 5467 5558
24-
Sep 5691.95 5709.85 5662.75 5671.65 5615 5556 5531 5590
25-
Sep 5674.90 5702.70 5652.45 5676.75 5660 5600 5574 5635
26-
Sep 5653.40 5672.80 5638.65 5657.60 5689 5634 5608 5663
27-
Sep 5673.75 5693.70 5639.70 5645.05 5692 5630 5604 5666
28-
 Sep 5684.80 5735.15 5683.45 5703.30 5679 5618 5592 5653

The downtrend from the last month continues into September until the
seventh of the month. The index broke out into a bullish trend on this date,
closing well above the buy trigger of 5264 at 5342, as witnessed on the
MHAF triggers worksheet.

You act to buy the Nifty futures at a price of around 5360. Looking at the
going price of 46 for call options of strike 5400, you may calculate the IV as
16.95 percent from the Option Pricing model. This seems rather low and
much below the threshold of 21 percent, and may not provide a good enough
profit looking at its lower IV.

Also, this premium gives a reversal point at 5314, which is far too near for
comfort, and the maximum profit from the combination comes to only 86,
which seems rather meek compared to its peers of previous months. You can
blame the lower IV of the call options in this month for that. Market players
do not seem to be looking forward to a bullish run this time and so are not
willing a high premium on the calls.

But remembering that an opposite movement from an exiting trend always

serves to increase the profit potential, you decide to go along with this
covered call, hoping for a trend reversal.

With this expectation you sit back to watch the progress of Nifty over the
coming days, looking out for the index going below your reversal trigger.

Alas! That never happens during the contract’s life cycle which ends the
expiry day of 27th September.

The index closes at 5649, granting you a profit of 289 points on the long
futures, but the short position in call options hands you a loss of 203 points so
that your net profit for the month comes to the already predicted maximum
profit of 86 points at the start of the bullish trend on 7th September.

What were market players thinking? Why was there such low implied
volatility at the start of the bullish trend? Does low IV suggests a long bull
run? I am afraid these questions cannot really be answered. We weave such
complex webs that evolve around us in such mysterious ways as to leave us
awestruck by our own creations.

Nonetheless, this single covered call strategy has showered a net profit of 86
units for the month of September. Looking back at the MHAF worksheet,
you might calculate that the candle following plan on the MHAF results in a
profit of 293 points.

The mice have won by a huge margin of 207 points this time around!

Before getting on to the next half of the year, let’s summarize what we have
achieved so far.
The First Half Results

Month Strategy Profit/Loss from Profit/Loss from

Strategy MHAF
Covered Calls followed by
April - 2012 160 60
partly Covered Puts
Covered Calls followed by
May - 2012 184 236
partly Covered Puts
June -2012 Covered Calls 178 -45
Covered Calls followed by
July – 2012 142 129
partly Covered Puts
August - 2012 Covered Calls 138 -23
September - 2012 Covered Calls 86 293
Sum of Profit/Loss 888 650

We, the humans, have been doing a little better than the mice and rather
consistently too in that so far we have not taken any loss in any month.

Let’s walk through the rest of the year now.

The Month of October – 2012

The bullish trend of September continued in the first week of October, until
the 8th day of October saw a reversal. The sell trigger for Nifty at 5706 was
breached around a closing of 5676 for the day.

This would prompt you to short Nifty futures at a price of 5700. To take a
contrary call, you might now consider selling put options at the nearer strike
of 5600. This is seen trading at a price 40 by the close of the day.

Using the goal seeking function in your Option Pricing worksheet, you find
that the IV for this option is at 12.4 percent, which is near the threshold of 13
for put options.

But since the maximum profit from this combination works out to be 140
points, you decide to go along with it.

The reversal point happens to be at 5740, which is quite near but remember
that if the trend does reverse to a bullish scenario, the maximum profit
potential usually increases from the previous combination.

As the Nifty progresses over the next days, you are only watching out for the
reversal point of 5740 to be breached. This never happens as the Nifty
stagnates in a narrow range of 5634 to 5729, finally closing at 5705 on the
expiry day falling on 25th October.

This scenario has turned up a loss of 5 points on the short futures and a profit
of 40 points on the short put options which expired worthless. Thus, a net
profit of 35 points has accrued this month in your trading account.

Let’s see how the MHAF trend following plan would have worked.

From the triggers suggested by your Heikin Ashi tables during this time from
8th October to 25th October, you can see that all the four trades taken during
this time resulted in losses totaling 168 points.

Whew! The CPR trading strategy certainly worked pretty well to avert that
huge loss for you this month.

The Month of November – 2012

This month is the only one of the twelve months that will compel you to act
on the third leg as reversals happens twice during the same month. So just to
make sure that you follow through the intricacies, I will reproduce here the
MHAF triggers table for your careful perusal.

Date NIFTY Buy StLoss Sell StLoss

25-
Oct 5688.80 5718.75 5685.70 5713.60 5730 5674 5648 5704
26-
Oct 5683.55 5697.20 5641.75 5663.85 5753 5690 5664 5727
29-
Oct 5665.20 5698.30 5645.10 5665.60 5735 5672 5647 5709
30-
Oct 5656.35 5689.90 5589.90 5597.90 5744 5666 5640 5718
31-
 Oct 5596.75 5624.40 5583.05 5614.85 5714 5656 5630 5688
1-
Nov 5609.85 5649.75 5601.95 5645.05 5683 5623 5597 5657
2-
Nov 5696.35 5711.30 5682.55 5697.70 5655 5602 5576 5630
5-
Nov 5693.05 5709.20 5679.50 5702.25 5689 5635 5610 5663
6-
Nov 5694.10 5730.80 5693.65 5724.40 5705 5648 5622 5679
7-
Nov 5718.60 5777.30 5711.40 5760.10 5722 5655 5630 5696
8-
Nov 5709.00 5744.50 5693.95 5738.75 5759 5698 5672 5733
9-
Nov 5731.10 5751.70 5677.75 5686.35 5772 5702 5676 5745
12-
Nov 5688.45 5718.90 5665.75 5686.80 5764 5702 5676 5738
13-
Nov 5689.70 5698.25 5660.35 5661.25 5753 5696 5670 5727
15-
Nov 5650.35 5651.65 5603.55 5631.00 5755 5694 5668 5729
16-
Nov 5624.80 5650.15 5559.80 5574.05 5737 5662 5636 5711
19-
Nov 5577.30 5592.75 5549.25 5571.40 5699 5640 5615 5673
20-
Nov 5604.80 5613.70 5548.35 5571.55 5665 5599 5574 5639
21-
Nov 5582.50 5620.20 5561.40 5614.80 5643 5579 5554 5617
22-
Nov 5628.60 5643.35 5608.00 5627.75 5630 5575 5550 5605
23-
Nov 5635.45 5637.75 5593.55 5626.60 5650 5592 5566 5625
26-
Nov 5648.65 5649.20 5623.45 5635.90 5646 5594 5568 5621
27-
Nov 5658.50 5733.20 5658.00 5727.45 5646 5577 5552 5621
29-
Nov 5736.70 5833.50 5736.10 5825.00 5667 5591 5566 5642

Notice that the trend turns bearish on the day immediately after the expiry of
October contracts on 26th October just below 5664 near the close of this
trading day. So having acquired honing trading skills by now, you would sell
the Nifty futures at the going price of 5702.
To create a contrary position, you should consider selling 5600 PE at a price
of 53 points. (May I remind you here to access the achieves at nseindia.com
and if you notice any discrepancy, write to me immediately from the ‘contact
me’ page at niftytracker.com).

This strike has a pretty small IV. Take a little time calculating this using your
Options Pricing model worksheet. Upon writing this put option, keep in mind
that the maximum profit from this strategy comes to:

MP = 5702 – 5600 + 53
= 155.

And the reversal point on the upside happens to be:

RV = 5702 – 53
= 5755.

This may seem close rather close but with the past few months’ experience
you are actually hoping for a reversal so that the maximum profit potential
may be revised upwards for you on the next leg of action.

As you watch the flow of Nifty, alert to the possibility of the market going
above 5755, you notice that on 7th November, the trend turns distinctly
bullish at the index spot value of 5760 as the closing price for the day. As you
square off your short futures at a price of 5793, taking a loss of 91 points, you
also contemplate selling call options of the nearer strike of 5800, which is
trading at 65 points or selling call options of strike 5900, trading at 28 points.

This phase of trading raises an interesting question of choosing the right

strike price to be sold. The choice is between selling the 5900 strike and the
5800 strike, and can easily be answered by calculating the breakeven and
reversal points.

Now, the maximum profit at the 5900 level is given by:

MP = (5900-5793 + 2*28 + 53 – 91)

 = 125.

The breakeven or exit point for the strike 5900 is given as:

BEu = 5900+ 125

= 6025.

The reversal point on the downside is calculated as:

BEd = RV = 5900 – 125

= 5775.

This is troubling because the spot value of Nifty is already 5760 which is
lower than the reversal point. Obviously then, the 5900 strike is not a valid
choice.

Switching to the 5800 strike, you decide to write the call options here for a
premium of 65 points. Now the maximum profit potential at 5800 level is
seen as:

MP = (5800 -5793 + 2*65 + 53 – 91)

= 99.

Oops! This is less than the initial maximum profit potential of 155. This fact
alone should warn you to be very careful on the next leg of action, should the
Nifty decide to reverse directions once more.

Let’s calculate the loss you would incur if you decided to chicken out now
and square off your positions today on 7th November.

You already have a loss of 91 points on the short futures but the short put
options are making a profit of 37 points since they are quoted at 16 points at
this time. So your net loss if you close out both positions comes to about (91-
37) which is 54 points.

But let’s go on to execute the reversal leg, if only to learn how the scenario
works out.
The maximum profit now stands at 99 points if Nifty closes at 5800 on the
expiry date. If Nifty continues to rise beyond 5800, the exit point on the
upside would be 5899 which would return a null profit if the Nifty closed at
this value on the expiry date.

On the downside, the reversal point would be 5701.

Now, since you have already taken two actions in this month, you allow
yourself just one more action on the next reversal, at the calculated reversal
point of 5701, or at the maximum profit level of 5800, and that is to square
off all your positions, take your profits or losses to get out of the market.

A reversal is indeed seen on the charts on 9th November when the Nifty is
seen closing at 5686, below the reversal point of 5701.
You can now initiate the third leg of your CPR futures and options strategy
by selling the long futures at the available price of 5723, taking another loss
of (5723-5793) which is 70 points.

As you begin to short the index futures according to your CPR trading plan,
you might pause to give a thought to the contrary action to go along with the
strategy. You may sell two lots of put options as you always do but that
would create three lots of put options of strike 5600 in your portfolio. And if
the Nifty drops to a level much below this strike, you may have to face a
huge loss with these three lots.

The contrary action for the short futures is therefore the writing of two put
options of strike 5600 at a price of 22 units.

You now have short futures of one lot at 5723, one lot of 5600 PE sold at a
price of 53 points, two lots of 5600 PE sold at the price of 22 points each, and
two lots of 5800 CE at a price of 65 points each.

Now, the maximum profit potential for this combination at the expiry level of
5600 is calculated as:

MP = (5723-5600 + 1*53 + 2*22 + 2*65 – 91 -70)

 = 189.

Great! Now the maximum profit potential has increased to 189 from the
original potential of 155 points.

The breakeven or exit point on the downside is estimated at:

BEd = 5600 – 189

= 5411.

And the breakeven or exit point on the upside is seen as:

BEu = 5600 + 189

= 5789.

The breakeven point on the upside is no longer called the reversal point since
the fourth leg of your action must only be to exit all positions.

All goes well with the daily closing Nifty not breaching these levels. Now the
exit plan comes into force from the 18th November since only 12 days are
left to expiry which falls on 29th November. The 13 days criterion includes
the trading holidays of Saturday and Sunday so 18th November is the day
from when you would be looking to get out of all positions should you see
the Nifty around the value of 5600, which is where you would reap most of
the MP attainable. The Delta could be nearly more than 0.8 during these days
and would only increase as the expiry day approaches.
Indeed, you do see this level, and let’s say that on 23rd November, when you
have the Nifty touching 5600 during the day, you decide to promptly square
off all positions.

These are the values for the various derivatives at which you would exit :

Futures, F4 = 5608
PE 5600, PP = 22
CE 5800, CP = 1.5

You can now calculate that the realized profit from this squaring off action as
below:

RP = (F3 – F4 + 1*PP1 + 2*PP2 + 2*CP1 – 3*PP – 2*CP + L1 + L2)

= (5723 – 5608 + 1*53 + 2* 22 +2*65 – 3*22 – 2*1.5 – 91 - 70)
= 112.

The exiting of all positions on this day when you spotted the Nifty value
around 5600 has not only resulted in a rather decent profit but just saved you
from a huge loss. The exit rule on the fourth leg of action is the only one that
needs your attention on the underlying asset’s spot price throughout the day.

Had you remained complacent and waited for the expiry day, you would have
churned up quite a loss as shown below:

For the spot value of 5825 at the close of the expiry day,
Realized Loss = (5723 – 5825 + 1* 53 + 2*22 + 2*65 – 3*0 – 2*25 – 91 –
70)
= - 86

Could you have foreseen this setback on the expiry day?

Looking back with the advantage of hindsight, you may need to appreciate
that the market can outwit the smartest strategy. The only means to
circumvent this peculiar tendency of the market is to humbly acknowledge
the fact and take care to square off all positions during the last 12 days of
trading (less than 13) prior to the expiry date when you see the maximum
profit potential level being touched.

Now, armed with this fresh insight to exit positions if the market offers you a
chance to book profits at the maximum profit potential value during the last
12 trading days, you go forth with greater confidence into the next months.

By the way, the trend following plan on the Heikin Ashi charts reveals that
you could have made a profit of 191 points from four trades conducted during
this period.

The MHAF trading plan wins again quite comfortably this month.
The Month of December – 2012

The bullish trend that begun on 27th November continues well into
December, until finally on the 13th December, you notice a clearly distinct
bearish trend with the Nifty closing at 5851 below the sell trigger of 5860.

Acting swiftly, you short the index futures at a price of 5877, simultaneously
selling the put options of strike 5800 which gets 31 points in your trading
account.

The maximum profit that can be had from this covered put strategy can be
seen to be 108 and the reversal point happens to be 5908 on the upside.

The 19th of December does see the Nifty closing well above this reversal
point at 5930, so you hastily square off the short futures at the going price of
5944 taking a loss of 67 points.

The expiry date for the December contracts is scheduled for 27th December,
which is just 8 days away. This factor alone necessitates that you close out all
positions as there won’t be enough premiums available in order to make the
transition to a bullish phase worthwhile.

But just as an exercise for polishing your trading skills, do let’s see how the
next triggers for reversals and the maximum profit potential work out.

If you reversed your short position in Nifty futures, you would be buying two
lots of the futures, one for squaring off the earlier shorts, taking a loss of 67
points, and the next for creating a long position. This would imply that you
sell two lots of call options for the nearest strike of 6000 to act out the
contrary requirements of your trading strategy.

The 6000 CE are trading at a price of 23 units, thus as you sell these options
you receive 46 points in your account. Now, the maximum profit potential at
the Nifty spot value of 6000 can be seen as:
MP = (6000 – 5944 + 1*31 + 2*23 – 67)
= 66

The breakeven point on the upside is estimated at:

BEu = 6000 +66
= 6066
While the reversal point on the downside is at:
RV = 6000 -66
= 5934.

This is very near the futures price value now, while the Nifty spot is already
below this value at 5930 and so the situation is screaming out an ABORT
warning.

Therefore, you decide to keep out of the market by squaring off your initial
positions, taking a loss of 67 on the short futures but taking a profit of 23
points on the short puts which you have bought back for 8 units.

This month has penalized you with a loss of 44 points. The MHAF trading
plan on the other hand gives a loss of 65 points over the same period, and if
you continue to trade the rest of the month with this trading, a total loss of
136 ensues.

Keeping out of trading the rest of the month with your CPR and exit plan
strategy has worked out fine for you after all.

The Month of January – 2013

A somewhat indecisive market since the expiry of last contracts finally turns
bullish at the start of this month on the 1st day of the year, with Nifty closing
at 5951 which is well above the buy trigger of 5921 on the MHAF worksheet.

You could buy the Nifty futures at a hefty premium price at 6007, and taking
the nearest call strike from Nifty spot of 5951 at 6000, also decide to sell
these call options at a price of 91 units.
This should give a maximum profit of 84 points and a comfortable reversal
point on the downside at 5916, while secretly hoping that perhaps the Nifty
would reverse trend just once so that the maximum profit potential could
move up a bit.

Over the next many days, you watch as the Nifty moves up and away and
back to its beginning levels, keeping alert to the possibility of Nifty breaching
5916 level which is never reached. The Nifty keeps in a narrow range and
closes finally at 6035, giving you the promised maximum net profit of 84
points.

Of course, with the lesson learnt from the month of November 2012, you
could have booked almost 90 percent of this profit during the last 8 trading
days of the month when the Nifty was hovering well around the maximum
profit target of 6091. Let this be an integral part of your trading style, so that
the pitfalls of the expiry day can be circumvented.

As you compare this profit to the simple MHAF chart trading, you note that
you could have taken a loss of 82 points. So far, the CPR F&O strategy is
keeping you on the right side of the markets.

The Month of February – 2013

The following month begins with a clear bearish trend right on the first day,
with the index closing at 5999 below the sell trigger of 6013.

Quite mechanically now, you create a covered put combination by selling the
Nifty futures at a price of 6037 and simultaneously selling the put options of
strike 5900, the one naturally lower to the Nifty spot value of 6013, at a price
of 35 units.

This suggests a maximum profit potential of 172 points on the downside and
a reversal point on the upside at 6072 which is rather close, but hey! You do
hope the market won’t remain where it is and give you a chance to make
greater profit by changing course.
Regardless of your expectations, or perhaps in line with your expectations,
the market never shows you the reversal point but continues moving
southwards to close the month at 5693 on the last day of the month which
was also the expiry day.

Again, in line with your lesson of November-2012, you could have squared
off your position during any of the last 8 trading days of the month, getting
about 90 percent of the stipulated profits since the index was trading below
the profit target price of 5865 ( given by the PS minus the premium).

The month delivered its promised profits of 172 points to you without any
hassles. And funnily enough, if you had followed the MHAF trend plan, you
would have made exactly the same amount of money!

Mice and men come out even this time.

The Month of March – 2013

The long bearish trend from February finally ended on 5th March, with the
Nifty closing at 5784, comfortably above the buy trigger of 5768.

This bullish scenario compelled you to buy the index futures at a price of
5802 and to simultaneously sell the call options of strike 5900 at a price of 31
units.

The combination promises a maximum profit potential of 129 points but

cautions on the downside reversal point at 5771 Nifty spot.

The Nifty does indeed close below this reversal point at 5746 on 19th March,
so you proceed to square off the long futures at a price of 5753, taking a loss
of 49 points.
Squaring off the call options at this time would entail paying back 13 units
which would give a profit of 18 units, thus reducing the net loss to 31 points.

Now, less than 13 days are left to expiry, so you would not want to take the
next step to go to Act II. But just as an exercise, let’s see what happens if you
do.
You are a bit hesitant about taking the next let of your strategy because just 9
days are left to the expiry of the contracts for this month which falls on 28th
March, and so you must reach your maximum profit potential within the next
few trading days.

Taking a peep at the put options price, you find that the 5700 strike puts are
still trading at 42 units, so you might still get 84 units in your account if you
go ahead.

Well, then you create a short position in futures at 5753, and sell two lots of
5700 PE at a price of 42 each. Calculating the reversal triggers and the
maximum profit potential at Nifty spot value of 5700 gives the following
figures:

Maximum Profit at Nifty spot 5700 = 119,

Reversal point on the upside = 5819, and
Breakeven or exit point on the downside = 5581.

There is a bit of a hesitation here as the profit potential is slightly lower than
the one promised at the start of the month, but since the reversal points are a
way off, you can go along with the strategy with the determination to get out
as soon as the spot value of 5700 is seen during the last 8 trading days of the
contracts’ lives.

As it happens, the spot value of 5700 that promises the maximum profit was
hit the next day as the Nifty closed around 5700 on 20th March.

Remembering the training from the month of November, you decide to exit
all positions since now only 8 days are left to expiry. The exit values for your
positions are shown below, as seen from the historical archives of
nseindia.com:

Futures, F3 = 5720
5800 CE, CP = 7
5700 PE, PP = 48.
The realized profit can now be calculated as below:

RP = (F2-F3 + 1*CP1 + 2*PP1 – 1*CP – 2*PP + L1)

= (5753-5720 + 31 + 2*42 – 7 – 2*48 – 49)
= - 4.

Well, that is actually a loss of 4 points, slightly less than the 31 point you
would have booked if you had decided not to go through the trades on 19th
March, but a loss nevertheless.

Now, how about checking to see if you had not squared off on 20th March but
decided to see the end on 28th March?

For this purpose in comparing the results of the CPR F&O strategy, we shall
be looking out to square off only when the closing Nifty violates the reversal
point. This never happens and at the close of the expiry day, the Nifty stands
at 5682.

You can then calculate that this closing results in a profit of 101 points for
this month. Squaring off about prior to this closing would have resulted in a
slightly lesser profit, but profits nonetheless.

While this action results in a net profit of 106 points, but with an earlier loss
of 49 points on the long futures from the first leg, the final profit comes to 57
points for this month.

For our comparative study, we shall consider the actual loss accrued of 31
points on 19th March. Note that the MHAF charting pattern returned a profit
of 91 points during this month.
The Second Half Results

Month Strategy Profit/Loss from Profit/Loss from

Strategy MHAF
October - 2012 Covered Puts 35 -168
Covered Puts followed by
November - 2012 partly Covered Calls and 112 191
partly Covered Puts again
December -2012 Covered Puts -44 -65
January – 2013 Covered Calls 84 -82
February - 2013 Covered Puts 172 172
Covered Calls followed by
March - 2013 -31 91
Covered Puts
Sum of Profit/Loss 328 139

The second half of the year has resulted in much smaller profits in both the
categories.
However, in spite of the some losses in two of the months, the CPR F&O
strategy has fared much better over the long run.

For the 12-month period, we have the net profit from the F&O strategy at
1216 and the net profit from trend charting pattern at 789.

It was only during the months of November and March that you squared off
all positions prior to the expiry day. Had you waited to see the expiry day
closings, you would have made slightly lower profit of 262 points for this
second half year trading, so squaring off during the last 12 days of the
contracts’ life seems a good idea after all.

And if you had opted to square off whenever you received about 80 percent
of the maximum profits available for the rest of the 10 months, you would
have made 1018 for this 12-month period which is still better than the trend
following plan. Note that we have so far completely ignored relevant delta
exits but still arrived at satisfactory results. Perhaps taking care to make sure
to exit at the right delta would have yielded even better profits with the
improvisation.

With these results and the trading strategy firmly established, you can now go
ahead and test the CPR on other indices, currencies, stocks or commodities.
If it doesn’t matter who wins or loses, then why do they keep score?
– Vince Lombardi.
6. In Conclusion: Outsmarting Mice
The mice may win the game by observing a pattern. They spot greens or reds
and bet on just one outcome to their advantage by noticing that greens tend to
appear more than the reds.

We can do that too.

And we can win further by not just observing and acknowledging patterns,
but by inventing and playing complex hedging tools like futures and options.
We can play the game to our advantage by devious means of planning
strategies to transform a simple game of: heads I win but tails I lose, to a
complex game of strategies that lead to a ‘Nash Equilibrium’. The movie “A
Beautiful Mind” (2001), made popular this brilliant mathematical approach of
John Nash, a Nobel Laureate in Economics.

With our complex financial tools, we can play the game to everyone’s
advantage approaching the Nash Equilibrium position where economic good
happens for all, and market transactions are no longer ‘zero-sum’ games of
heads I win to tails you win.

Various strategies played out by numerous market players make winning the
game all the more easier for everyone. So there are even more complicated
strategies of calendar spreads involving derivatives of different months and
simpler ones of options spreads and covered calls or puts, or protective puts
and calls. There are also the fancy named butterflies, straddles, collar and
condors, all played out in our markets but ultimately approaching the Nash
equilibrium together in unison.

For more complex strategies, even more mathematics may be involved along
with its associated what-if scenarios. Unless you have this gift of abstract
mathematical acumen, it would be best to stick with a simple strategy that
you can easily work out and that becomes second nature to you. But
remember, no strategy is perfect, at least not perfect enough to yield
maximum profits every time.

With the CPR F & O strategy explained here and its simple calculations, you
have a method for playing out the game month by month. You have seen that
as soon as you initiate trades, you immediately have your what-if scenarios
for reversals and exits worked out for the rest of the month. A great thing
about the strategy is that you can plan your actions only near the closing bell
for the day, except for the day when you have to exit at the maximum profit
potential level during the last days of the contracts’ lives.
Intra-day fluctuations no longer bother you, the optimism bias is done away
and you also throw the two emotions of fear and greed out the window.

The strategy can also be applied to stocks, currencies or commodity

derivatives, as well other indices where futures and options are actively
traded. It is just a question of how many instruments you can handle every
month. I would suggest no more than five, comprised of a couple of indices
and your favorite stocks or currencies if these are very actively traded on
your exchange.

As a Taoist would say: Less is More.

Please feel free to interact with me through my website at niftytracker.com

and remember to sign up for receiving updates to the book and an occasional
newsletter there. There may yet be some oversights in text or formulae or
figures, even though I have gone through the book’s figures many times over.
Do point these out when you find them by contacting me through my
website.

Since your views are very important to authors and their book, please visit
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Happy Trading!
 Other books by Avinash Khilnani:

The Modified Heikin Ashi Fibonacci Trading System

The book guides the readers in creating a personalized trading system that
allows for the laws of large numbers and probabilities in an unpredictable
place to work in their favor by keeping their trading actions in sync with
unpredictable trends of market price of indices, stocks or currencies.

That goal is achieved by modifying the standard Heikin Ashi chart quite a bit
and using the Fibonacci ratios to create triggers for entry and exit points
while instructing the readers in detail to create their own spreadsheet and
charts, assuming the readers have some working knowledge of a spreadsheet.

The Fibonacci Dictated Trading Script

A stage play is set for playing index futures against index options,
demonstrated as a real world example of the Dow E-mini futures and the DJX
options. The reader is guided to write a trading script for the stage before the
play actually begins as a simple Excel worksheet. Fibonacci ratios and
numbers dictate the writing of the script and extensive use of the Black-
Scholes option pricing model ensures that optimum exit point, reversal
points, profit or loss, rolling up or rolling down figures are calculated well in
advance of the actual play.
 Genetic Hacking: Your DNA Can Be Hacked!

Are you literate enough in the codes of life, of reading and writing DNA?
And should you be hacking your own biology?

Is it possible for you to evolve quicker than nature intended and can you be
intentionally creating genetically superior children by design? In a slightly
futuristic scenario, you could live healthily (and happily) ever after through
hacking your genome and connectome by re-booting your genome with your
connectome again and again.

This book explains why it is about time you hacked your own DNA and
shows how the recent developments in genetics and genomics enable you to
understand your personal biology. The benefits of bio-hacking yourself range
from personalized medicine for your quantified self to looking into your
ancient past to trace your personal ancestors to get to know yourself better.