9 MUST HAVE trading tools that every Option trader DESERVE

Updated: May 27, 2020

Do any of NSE Brokers have them?

Friends, from June1, 2020 SEBI’s new margin rules come in to effect for trading in Indian stock markets be it cash or derivative. This rule will raise the margins for naked option writers and future traders without a hedge. At the same time, margins for limited risk option strategies will drop big time!!.

One calculation put out by a discount broker Zerodha shows that the margins could drop from 50 to 70 %. Margin for a vertical spread could be as little as Rs.25k. Great time to be a option spread trader. Isn’t it? But naked option sellers and future traders are not that lucky. The margin for each contract of Nifty could raise to Rs.1.25 lakhs but the worst news is that even this high margin could raise even further if there is a spike in volatility. No one will know when will a bad news hit markets especially during these pandemic times. Panic could cause a spike in volatility that is around 30% now to 50…60… or even it can go back to 80s.. That is a nightmare scenario for traders who trade derivatives without a proper hedge.

The broker could without warning, square off the position of a trader if and when volatility spikes and leave the trader high and dry!!

Therefore it is important to for derivative traders to move to options strategies and learn how to effectively hedge a position. There is however one major problem for strategy traders. Trading platforms offered by NSE brokers are already stretched and on the brink. During volatile markets they throw up error messages, breakdown, hang, disconnect and do all kind of drama. Have you guys seen how many traders vent their anger and frustration in one of those trader’s chat/discussion forums... God knows how many have blown their account because of these pathetic trading platforms.

There is no way these trading platforms can handle option spread trading that requires seem less flow of data. Imagine a situation where trader who want to do a vertical spread, first writes an option and by the time he places order for a hedge, the system hangs. Pure hell right?

Let me come to the point. I want to show you guys 9 MUST HAVE SCREENS… every option spread trader DESERVE. I trade with interactive brokers(IB) and the following screen shots are from my paper trading account. Every trader with Interactive Brokers (IB) is allowed to open one paper trading account to test strategies/ new features etc. I took screen shots from paper trading account because I did not want to mess up with my real trading accounts’ desk top set up. Also note that this paper trading account connects to same server real trading account connects therefore the price quotes are as fast and real time. This screen shots are taken on Sunday, So all price quotes are as per Friday’s close.

IB’s Trader workstation is one of most advanced trading platform in the world. They offer many cool advanced feature completely free of cost.

Let’s go

No.1 is the option trading screen

IB has several desktop set-ups that are suitable for different type of traders. For example, a scalper can use a screen called “book trader” where the orders can be placed from deep book window and have features to easily reverse or close positions

Option trading screen complete with option chain, strategy builder and order book, and strategy watchlist is suitable for option traders. Some of the cool features are:

  • Traders can custom build a strategy or choose most commonly used strategies such as bull spread, diagonal etc.

  • Clicking “profile” button will show pay off diagram that contains max profit, max loss, probability of win and also how P/L and Greeks will behave on different dates up to expiry of the spread.

  • The whole spread could be added to the quote panel where the bid/ask of the whole combo and other Greeks can be seen and monitored.

  • Order can be placed for “day” or “Good-till-cancelled”

But the coolest feature is, order for whole strategy can be placed with any of the three algo order types

  1. REL+MKT – This means one leg will be filled at relative price that is best possible price for that leg. Second / other legs will be filled at market price so that the combo is finished quickly. Overall, the cost of the strategy will be around the trigger price mentioned by trader. This type of order ensures quick fill but slippage of around 0.50 to a Rupee trigger price will likely happen.

  2. REL+LMT – Similar to the above except that the second leg is filled as limit order to ensure the price stays within the trigger price mentioned by the trader. Here the focus is on the cost of the spread. Slippages from trigger price is rare.

  3. LMT+MKT- Here the first leg is limit order and second leg is market order

  4. Orders are kept at IB’s server. Algos continuously keep track of the order flow and the order is placed only when there is likelihood of combination getting filled.

II. Real time option volume Chart

This cool feature will tell us how the volume of each strike is behaving, which strikes are added and which one are being squared off. The data for previous dates can also be seen by choosing a different date from “Date” drop down menu on the top-right. By looking at this chart, it is easy to see where the max-pain is and how its likely to move by checking previous day’s option volume vis-à-vis price movement.

III. Implied volatility viewer

Option spread trading is about volatility trading as much as its about price direction. Implied volatility is what tells the trader about how costly or cheap an option is. The window will chart "volatility smile" for each expiry. This is the most helpful feature for calendar and diagonal spread trading. I used to do a lot of them when the IV used to be low. That’s because calendar / diagonals have a statistical edge in low volatility markets.

Trader can choose any expiry from the drop-down menu to chart the volatility smile. For options, volatility smile that is parabolic curve resembling a smiley face is normal. But most of the time there are mis-pricing and the smile becomes “Skewed”, meaning the smile is not perfect and one side of the smile raises or falls. This will present a volatility arbitrage opportunity. That is high IV option can be sold and hedged with low IV options.

IV. Historical Volatility & Implied volatility

Another MUST HAVE window for option spread traders is Historical volatility Vs Implied volatility. That is actual volatility Vs volatility implied or priced in by cost of ATM options

One of the advantage option sellers enjoy is they sell options at higher implied volatility than the actual volatility there by pocketing excess time value. That’s why option writers try to sell option during sharp spikes in prices which basically offers them higher premium.

This window will show the traders how the implied volatility is behaving vis-à-vis price movement and actual volatility. White line is that of IV, yellow and orange lines are 10,20 days actual volatility respectively

V. Option strategy scanner

The next MUST HAVE screen is option strategy scanner. It is completely normal for newbie spread trader to be overwhelmed by so many strikes, different expires and fast-moving implied volatility. Initially I went nuts and used to tweak around this scanner for hours after market is closed. So to start off, this scanner is very handy. Here trader can input different parameters such as price forecast, whether it will be range bound or trending and by how many percentages from current price etc. The strategies can also be filtered by parameters such as delta, strike prices etc.

Once “Done” button is hit… the system will list several strategies suitable for prevailing volatility and trader’s forecast. Each strategy will show P/L pay off chart and Greek on specific dates

VI. Probability Lab

Next up in the list of MUST HAVE screens is “Probability Lab”. This is exclusive patented program of interactive brokers.

Once the traders gain some experience in spread trading, he/she may want to experiment with the probability. The below screen shows the market implied probability. For example, as on Fridays’ close the market assigns highest probability of 30.21% for the prices to close at 9047.64 on May 28 expiry. Now a trader may have different view, he may feel that market mood is off and probability is highest to close at 9500 or above. In this case, the trader can adjust the probability by pulling up or down each pink coloured column to get his forecasted probability. Then if “Build strategy” button is clicked, the system will list strategies that are suitable for forecasted scenario.

Traders can adjust the strategy, check the P/L pay off chart as well as place order from this window.

VII. Volatility Lab

Then we have volatility lab. This window has three pages, historical volatility that is similar to what we have discussed above. Implied volatility page will chart how implied volatility of different expires are progressing. A background price line chart is also shown. The chart below shows the volatility profile of both historical volatility and IV for entire expiries. I mean the trading platform presents the trader with so much information that trader can imagine and work on his strategy peacefully.

VII. Volatility Lab- Industry comparison

In this page of volatility lab window, trader can compare the volatility of several scrips or indices. This is very useful to choose the right underlying based on relative volatility movement Vs price moves of underlying.

VII. Risk management tool – What-If -Scenario

Last but not least. This MUST HAVE window is mother of all risk management tool. If a trader already has few spreads in his portfolio and wants to know what is the overall

  • value-at-risk,

  • Greeks,

  • Margin

  • and how risk, P/L and Greeks can be managed by adding a new or several new positions.

Traders can simply click on the green colour “NEW” button and add the instrument / option he/she wants to add. A report can be generated from bottom-right corner by choosing different options from drop down menu.

Now tell me how long will it take for other NSE brokers to offer this kind of sophisticated tools to traders without any additional cost.

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