An Options Corner Special by GFT Markets – Which way for the DAX?

With effect from today, we will be running a bi monthly Option Corner special each weekend with GFT Markets in which they will look to educate our readership about just how options can be used in their trading.

We start this month with a selection of potential DAX strategies, depending on your view on the markets.

Which Option Strategy works for me? 

Many investors hear the world ‘option’ and run a mile!  But why?  Options can be lower risk than trading outright futures/cash/rolling markets.  Buying an option means you can never lose more than the price you pay for the option.  Selling options does however come with the risk of losing more than your account balance.  We explore four different market views and trade ideas for each one.  These are all based on the following table showing DAX September option prices based on a DAX cash level of 9120.

Andrew: “DAX has bottomed out and will rally back to 10000 within weeks”:

Strategy idea 1: Buy a Call

Buy the 9800 Call at 13.  With an account balance of GBP 2,500 Andrew could buy £192 per point.  If DAX finishes at 10,000 for the September expiry then the option will be expired at a price of 200.  Netting Andrew a 187 point profit or £35,904.  If things don’t work out (e.g. DAX carries on plummeting) then Andrew will only lose the price he paid; 13 x £192 per point = £2,496. So this might be a good trade idea if you are worried about getting closed out by margin call or losing more than is in your account as £2,496 is the worst possible outcome.

Strategy idea 1: Sell a Put

Sell the 8200 Put at 31. With an account balance of GBP 2,500 Andrew could sell £80 per point. This strategy pays out 31 x £80 = £2,480 if DAX finishes higher than 8200.  That means he can actually afford for DAX to drop nearly 1,000 points for expiry before he has any losses. 

Ben: “This is the right level for DAX now.  No lower than 8500 and no higher than 9700 for the next month or so”:

Strategy idea 1: Sell a Strangle

Given Ben’s opinion the Strangle could be constructed by selling the 8500 Put at 59 and selling the 9700 Call at 23.  With GBP 2,500 in his account Ben could sell £47 per point of each of these options.  This earns him a potential profit of £3,854 which he will earn if DAX is anywhere between 8500 and 9700 at the September expiry.  He starts to lose money if DAX is below 8418 (8500 – 59 -23) or above 9782 (9700 + 59 + 23) at expiry and makes a profit if DAX finishes anywhere between these values.

Caroline:  “DAX drop is only half done.  Expect it to drop to 8000… or maybe lower by September expiry”:

Strategy idea 1: Buy a Put

Buy £42 per point of the 8500 Put at 59.  If DAX is at 8000 for the September expiry then Caroline will make £18,522.  If DAX fails to drop below 8500 then Caroline will lose a maximum of £2,478.

Strategy idea 1: Buy a Put Spread

Buying a Put Spread is a lower cost strategy than buying an outright Put.  Also the margin is less as the two legs to the strategy partly hedge each other.  In this example Caroline decides to risk the GBP 2,500 in her account and Buy £64 per point of the 8500 Put at 59.  At the same time she sells £64 per point of the 8000 Put at 20.  The net cost of this strategy is 39 points or £2,496 (this is the worst case loss).  The best case is capped at 461 points (or £29,504) and occurs if DAX is at or below 8000 at expiry.  The PL can be seen in the diagram below.

David: “DAX hasn’t finished it’s sell off yet.  It will drop to 8000 but no lower”:

Strategy idea 1: Buy a Ratio Put Spread

David’s view is similar to Caroline’s however David thinks DAX will not drop lower than 8000.  Therefore he decides to sell 2x the 8000 Put and buy 1x the 8500 Put.  Selling twice the amount of the 8000 Put actually reduces the margin even further as the hedge is more balanced.  With only GBP 2,500 in his account David can buy £475 per point of the 8500 Put at 39 and sell £950 per point of the 8000 Put at 20.  The strategy is in fact traded for a credit of 1 point (20 x 2 – 39 = 1)!  Meaning if DAX is anywhere above 7499 at expiry then David will make a profit.  David will make a maximum of 501 points or £237,975 if DAX is at 8000 at expiry.  And if DAX doesn’t move then David will make 1 point or £475 profit.  Here’s the PL profile.

As we can see options can be used in many circumstances.  The margins in these examples were calculated using the GFT Markets option margin methodology.