Trade like a Barbell

A barbell is a piece of exercise equipment used in weight training, bodybuilding, weightlifting and power lifting, consisting of a long bar with weights attached at end. The bar is empty in the middle and has weights on the extreme ends. I am sure you must be wondering what options have to do with a barbell. Well, it’s one of the most interesting strategies for option traders specially for new traders.

Now, what is it all about? As traders we tend to stay somewhere around mediocre risk zone. This tends to limit our returns capability. Here we play it differently!!!

Just the way the barbell has weights on the extreme ends we play our strategy on the extreme ends. One is extremely low risk and other is extremely high risk. While the low risk strategy keeps the capital intact the high risk strategy opens door for sharp gains. As an options player we can use this by putting a part of our money in fixed income securities and partly into high risk option strategies. So while the fixed income securities keeps the risk and capital under check the high risk option strategies will help generate some high returns.

For instance if one has Rs. 100 of capital to invest and the current rate of interest is 10%. You invest Rs 91/- in fixed income which at the end of the year will give the capital back. While rest of the funds can be used to invest in buying OTM options. The premium in case of OTM options is generally around 1% – 1.5% of the spot price. This helps one generate exposure of ~75% of the capital.

Also, the idea here is to buy OTM or deep OTM options. Though this makes the strategy risky as there is a high probability that most of these options will be wasted the returns can be phenomenal in case of sharp moves in the underlying.  Like, in this month we moved from near 10100 to 10700 and 10700 Call moved from near INR 40/- to INR 140/-. Such is the power of OTM options position. The non-linearity of returns can be extremely sharp. On the other hand, they being cheap can be well funded via fixed income returns.

So, it’s not that out of the box thinking can be always be costly. Here we can constantly take bets for unusual moves without hurting our trading capital.  For, new option traders this is a safe way to start; keeps capital intact and helps one learn a lot.

Happy Trading!!!

Cheers.