trading strategies: ETMarkets Smart Talk: Can index options offer fixed deposit-like returns? Aditya Singhania explains

Edited Excerpts –

Trading with index options is a brilliant strategy but how does it work?
Index options trading allows market participants to gain exposure to broader market movements without directly holding individual stocks.

These options are based on benchmark indices like the Nifty and Sensex and can be used for hedging, speculation, or generating income.

Best part is that unlike stock options, index options are cash-settled, eliminating delivery risks.

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For low-risk traders like myself, the focus is on deploying a broad mix of directional and non- directional strategies that benefit from time decay (theta) while maintaining minimal exposure to sharp market movements.By structuring trades such as credit spreads, iron condors and calendar spreads one can systematically extract returns from market inefficiencies while keeping risk in check. How can it generate returns that are relatively risk-free, much in line with fixed deposits?
While no market strategy is truly risk-free, well-structured options trades can offer predictable, consistent returns with low capital exposure—often similar to or better than fixed deposits.

For instance, strategies like cash-secured puts, covered calls, and properly hedged credit spreads allow traders to earn a steady income by collecting premiums while capping downside risks.

The key lies in proper position sizing and disciplined risk management to ensure that the probability of significant loss is minimal.

A well-optimized low-risk options strategy can yield 10-12% annualized returns, making it a viable alternative to traditional fixed-income instruments for sophisticated investors.

Also, these returns would be over and above the portfolio returns as the margin required for these options strategies can be availed by pledging the stocks, Mutual funds and ETFs in the investors portfolio. So it’s a win-win.

How do institutional and retail investors use index options?
Institutional investors primarily use index options for portfolio hedging, volatility arbitrage, and structured derivatives trades. Large funds deploy complex strategies like dispersion trading, delta-neutral hedging, and statistical arbitrage.

• Retail investors, on the other hand, often use index options for directional option buying, income generation, or risk management. Many retail traders leverage weekly options for short-term strategies like straddles and strangles and try to capture the rapid time decay on expiry days.

What are some common misperceptions about trading index options?
1. “Options trading is highly risky.” While aggressive speculation can be risky, properly managed risk-defined strategies significantly reduce exposure.

2. “Only directional traders make money in options. Or only non-directional trades make money” In reality, a large portion of successful options traders profit from a mix of multiple strategies and try to cover multiple scenarios.

3. “Retail traders cannot compete with institutions.” While institutions have advantages in speed and resources, retail traders can excel in low-risk strategies with proper disciplined approach and execution.

How effective is the calendar spread strategy in capturing time decay with minimal directional risk?
A calendar spread (buying a long-term option and selling a short-term option at the same strike price) is an excellent low-risk strategy for benefiting from time decay while limiting directional exposure.

• When volatility is low, calendars can expand in value as implied volatility rises.
• In neutral to slightly trending markets, they offer a controlled way to extract premium without excessive risk.
• With proper strike selection and risk management, they can generate steady returns with minimal capital deployment.

In volatile markets, how can traders adjust their option strategies to maintain relatively risk-free returns?
Volatility creates both risk and opportunity. To navigate it effectively:

• Widen the breakeven range by using iron condors or butterflies with further OTM strikes.
• Switch to delta-neutral strategies like calendar spreads or ratio spreads to minimize directional exposure.
• Hedge aggressively by rolling positions or adding protective puts.
• Increase cash allocation and reduce leverage to withstand market swings.

By focusing on probability-based trades rather than high-risk speculation, traders can sustain returns even in unpredictable conditions.

How can an investor hedge their portfolio using index options while still maintaining steady returns?
Investors can use index options to hedge their equity portfolios while ensuring stable returns through:

• Protective puts: Buying Nifty or Sensex puts as insurance against market downturns especially on event days like budget, elections etc.
• Covered calls: Writing index calls against existing equity holdings to generate income while capping upside.
• Ratio spreads: Combining long and short positions to hedge exposure while collecting

(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)