Generating a return which coincides with a broad index can just be done by buying an Index Fund which tracks the particular Index. ETFs aim is to replicate the performance of the underlying index by holding the same stocks in the same proportions as the index itself. In India there are several fund houses which offer investing to track the return of a particular Index like Nifty50, Banknifty among others. Most of these Index tracking funds are actively traded in stock exchanges - NIFTYBEES, BANKBEES etc., which enable the investor to buy and sell like stocks of any listed company. This strategy provides investors with exposure to a diversified portfolio of stocks within a particular market segment or index.

Nifty Bank Index compared with Bankbees ETF. If you see the graph, ETFs are efficiently being able to track the underlying Index.

Bank Nifty has given a return of 85% since the beginning of 2018 to end of 2023. Investors would have got the return just by Investing in an ETF, which translates to 12%-15% CAGR.

Is it possible to generate alpha over Index returns at same time minimizing the risk?

Let’s explore options contracts to see if we can get an Alpha.

The premiums available for BANKNIFTY ATM (At the Money) Call weekly contracts is around Rs.520 (45900 strike). The premium would vary based on the market volatility say from Rs.400 (low volatile market) to Rs.550. Let's assume Rs.450 as an average weekly premium.

This would translate into Rs.23,400 (450*52 weeks) per year, that is 50% of the underlying value. It means if BANKNIFTY remains at same level throughout the year, one could just gain 50% return assuming the premium would also be at Rs.450 every week. That’s hypothetical, what's fun in the market if there is no action!

But what will happen if we buy the ETF and sell ATM Call option contract and roll it over every week.

So to implement the strategy we would buy BANKBEES worth Rs.632,950 (25318*25 lot size) which translates to 2,455 qty of Bankbees.

Idea is to buy and hold Bankbees and sell and rollover weekly ATM call option contract. To sell an options contract you do not need additional margin as you can pledge your Bankbees. We would probably need 50% of the margin required to short an option contract in cash to meet brokers margin requirement and for withstanding MTM fluctuations (that is, approx Rs.100,000). Total investment we considering for the model is Rs.8 lakhs (Rs.6.33 lakhs +1 lakh+buffer).


Bingo, the simple rollover strategy generated the return of 100% since 2018, an additional 20% over the Index.

As the idea behind writing a call option is to protect the downside by the tune of the premium. In case market moves up, it would restrict the gains up to the premium of the contract.

Let’s see how much downside was protected?

During covid crash the index lost up to 60% whereas the strategy was able to restrict the loss to 33%.

Let’s try managing the options contract. In this approach, we try to improve upon the above strategy by incorporating a directional bias. Instead of rolling over the ATM call every week and limiting our profit potential during rallies, we intend to sell the call only when there is a loss of upside momentum and refrain from it during substantial rallies. The rationale behind this is to follow the prevailing market trend and hedge our investments only when it is required. This approach can be useful in reducing the hedging cost of our portfolio, thereby generating more potential profit. Let's look at the performance of the strategy over the same 5-year period:

We used our internal short term momentum model to identify the market cycle.

Note: Income generated through selling the call option is not re-invested

The modified model generated 130% return against 80% in benchmark and 100% in simple rollover, while the max DD remained at 33% during covid but slightly improved in other times. Unutilised cash gains at the end of period is Rs.4L (8L*50%(130%-80%).

In conclusion, both the approaches showcase their effectiveness in managing drawdowns through the strategic use of selling call options. However, the second approach stands out for its ability to generate superior alpha while keeping drawdowns at the same level as the first approach.

At Inuvest, we research quantitative models to generate alpha and protect capital at the same time.

 to know more about our models and how we leverage technology to generate an alpha.

Generating Alpha on broad market Index

The financial world is fraught with uncertainties. Just like an umbrella shields you from rain, hedging in the world of options can be a protective measure against unforeseen market movements. This blog post will explore the ins and outs of options hedging, its significance, and some popular strategies employed by traders.

Hedging is an investment technique used to reduce the risk of adverse price movements in an asset. Essentially, hedgers use instruments like options to protect against potential losses in their portfolio.

 Options provide the flexibility to hedge against both upward and downward price movements.

 Options often require a lower upfront investment compared to the underlying asset.

 With options, the maximum risk is the premium paid, allowing for better risk management.

 This involves buying a put option for an asset you already own. If the asset’s price falls, gains from the put option can offset the losses from the asset.

 Here, an investor holding a long position in an asset sells call options on that same asset. This strategy generates additional income (the premium) but caps potential upside gains.

 A collar is a combination of a covered call and a protective put. It offers protection from significant declines while also providing income through the sale of the call option. However, it also limits potential upside.

 For those with a diversified portfolio, hedging each stock individually might be cumbersome. Using index options, investors can hedge their entire portfolio against market downturns.

 This strategy aims to make an options position delta-neutral, meaning the position won't change in value for small changes in the underlying asset's price. It involves adjusting the number of options based on the delta.

 While hedging provides protection, it's not free. Evaluate the costs associated with the hedge versus the potential benefit.

 As market conditions and your portfolio change, adjust your hedges accordingly.

 External factors like interest rate changes, geopolitical events, or major economic announcements can impact the effectiveness of your hedge.

 Have a clear plan on when and how to unwind your hedge.

 Over-hedging can eliminate potential profits. Ensure you're using just the right amount of protection for your portfolio.

While the idea of hedging sounds appealing, it's not a one-size-fits-all strategy. It requires careful planning, regular monitoring, and a deep understanding of the instruments being used. Nevertheless, when implemented correctly, options hedging can be a valuable tool in an investor’s toolkit, offering peace of mind in volatile markets.

It's crucial to remember that all investment strategies, including hedging, carry risks. Always consult with a financial expert to understand these risks and develop a plan tailored to your specific needs and objectives.

Options Hedging: Safeguarding Your Investments

Options trading is a dynamic and versatile strategy in the world of finance. It offers traders the opportunity to profit from price movements in various underlying assets while managing risk effectively. To navigate the complex world of options, understanding the concept of liquidity is paramount. In option trading, liquidity plays a pivotal role in determining the ease of executing trades, managing positions, and optimizing strategies. This blog will explore the Liquidity Index from the perspective of option trading, discussing its significance, measurement, and impact on trading decisions.

The Liquidity Index is a numerical measure that quantifies the liquidity of an asset, such as stocks, bonds, cryptocurrencies, or their derivatives contracts. It provides insights into the ease of buying or selling an asset in the market without causing substantial price fluctuations. Liquidity is an essential factor because it affects the efficiency and stability of financial markets. High-liquidity assets are typically easier to trade, while low-liquidity assets may be subject to higher price volatility and trading costs.

The Liquidity Index is calculated using various factors, depending on the asset class being analyzed. Here are some common methods for calculating liquidity indices:

 This is one of the simplest ways to measure liquidity. The bid-ask spread represents the difference between the highest price a buyer is willing to pay (bid) and the lowest price a seller is willing to accept (ask). A narrow spread indicates higher liquidity.

 Liquidity can also be gauged by examining the trading volume of an asset. Higher trading volumes generally indicate greater liquidity.

 For assets traded on order-book exchanges, the depth of the order book is crucial. It shows how many buy and sell orders are available at different price levels. Deeper order books imply higher liquidity.

 Some liquidity indices consider the potential price impact of a large trade. The less an asset's price moves when a significant order is executed, the higher its liquidity.

 Some indices incorporate historical data, such as past bid-ask spreads, trading volumes, and price volatility, to assess liquidity.

The Significance of Liquidity in Option Trading

In the context of options trading, liquidity takes on heightened importance due to the unique characteristics of options. Here's why liquidity matters:

 Timely execution of option trades is critical, as options have expiration dates and are often used for short-term trading strategies. Liquidity ensures that you can enter and exit positions without significant delays or slippage.

 In the options market, the bid-ask spread is a key indicator of liquidity. A narrower spread suggests higher liquidity, reducing the cost of entering and exiting positions.

 Liquid options typically have more available strike prices, allowing traders to fine-tune their strategies with precision. Selecting a liquid strike is critical.

 Liquidity aids in risk management by providing the flexibility to adjust or close positions as market conditions change.

 Options strategies like spreads, straddles, and butterflies often involve multiple contracts with varying expiration dates and strike prices. High liquidity makes it easier to construct and manage these multi-leg strategies.

When incorporating liquidity analysis into your option trading decisions, consider the following tips:

 Focus on trading options with high liquidity to minimize trading costs and maximize flexibility.

 Keep an eye on bid-ask spreads, especially for options with lower volumes. Avoid trading when spreads are excessively wide.

 Consider options on a diverse range of underlying assets to ensure access to liquid markets.

 Stick to options with expiration dates that have sufficient trading activity. Illiquid options near expiration can lead to challenges in executing trades.

 In illiquid markets, use limit orders to specify the price at which you are willing to trade. This can help avoid unfavorable executions.

Using the above methodologies 1lyoptions is the only platform in India that provides the Liquidity Index (LIX) of the instrument. This can be found in various sections of the platform.

In the option chain, we have a specific column for LIX to help users to know the liquidity at each strike level.

In straddle premium, the LIX is the average of ATM call and put options. This helps traders to decide on which underlying assets have low liquidity (<4) and avoid them.

In every place order popup at 1lyoption would have an LIX value to help users avoid illiquid contracts.

In options, a particular strike might be liquid when entering the position but it might become illiquid generally when it goes to In The Money. 1lyoption gives alerts and identifies the specific position that has the risk of liquidity.

Liquidity is a fundamental factor for success in options trading. As an options trader, understanding and effectively measuring liquidity risk through metrics like trading volume, open interest, and bid-ask spreads is crucial. At 1lyption combines these matrices and quantifies the liquidity in numeric value ranging from 0 to 10. 0 being highly illiquid and 10 being highly liquid. By prioritizing liquid options and making informed decisions based on liquidity analysis, you can enhance your ability to execute strategies, manage risk, and achieve your trading objectives. In the dynamic world of options, liquidity is your ally in navigating the markets with confidence.

News, tips and expert insights to accelerate your trading

Generating Alpha on broad market Index

Options Hedging: Safeguarding Your Investments

Liquidity Index (LIX) in Option Trading: A Crucial Metric for Options Traders