Option trading has come to assume importance in the working of the derivatives market because it offers traders flexibility, risk management tools, and avenues for profit in rising and falling markets alike. Retail participants tend to base their trading habits on some simple strategies relating to buying calls or puts; on the other hand, professional traders use more advanced and perhaps lesser-known approaches to manage their market exposure and capitalize on subtle market opportunities. Such strategies might juxtapose options against index futures, take advantage of volatility changes, or establish a position representing some degree of opinion on market direction, time decay, and hedging requirements.
1. Ratio Spreads With Index Futures
A ratio spread is a strategy whereby a set number of option contracts are bought, while a larger number of contracts are simultaneously sold at different strike prices. Professional traders often favor this approach when they expect only limited movement in the underlying index but wish to profit from option premiums.
2. Calendar Spreads as a Volatility Play
These plays are short long options with an equal strike price under different expiry dates, relying on the difference in time decay and implied volatilities of short- and long-dated options.
The calendar spread will generally be used by pros relaxed in the near term yet expecting an increase in volatility at a later stage. For instance, if an index is alternatively moving sideways, write a short dated option trading and buy a longer-dated one. As volatility picks up close to the longer expiry, the long option appreciates in value, providing capital gains. The addition of index futures could fine-tune the directional exposure of the trade, creating flexibility as market sentiment changes.
3. Gamma Scalping with Index Futures
Gamma scalping is about making continuous and dynamic adjustments to some long futures or stock position intended to capture profits given fluctuations in the market. Long option positions generate positive gamma; therefore, gamma scalping typically goes hand in hand with long options.
4. Diagonals with Strategic Hedging
Diagonal spreads are a mix of calendar spreads and vertical spreads. They involve buying and selling options with different strike prices and different expiries. Professional traders apply this technique when they want to have a directional view while actually managing their volatility exposure.
For instance, in one example, a trader could buy a longer-term call at one strike and sell a near-term call at a higher strike. This would benefit from decay of the short option and hopefully some price move in the favour of the long option if the market grinds up. Meanwhile, the trade position can be fine-tuned with index futures, so that the whole portfolio remains in the intended direction.
5. Synthetic Positions for Capital Efficiency
Synthetic positions share the same payoff as physical ownership of stock or index but do so by trading combinations of options and futures instead. In this context, a long synthetic position in the underlying is created by buying a call and selling a put at the same strike price.
Professional traders like them because synthetic positions are often less capital intensive and can be modified easily. When combined with index futures, they help manage short-term risk or increase leverage in a controlled manner. Since margin requirements for futures are often lower than for outright stock purchases, this increases capital efficiency while maintaining directional exposure.
6. Iron Flies with Futures Overlay
The iron butterfly-neutral option strategy consists of selling an at-the-money straddle and buying protective wings at out-of-the-money strikes. This creates a position that profits from low volatility as long as the underlying remains near the central strike.
7. Volatility Arbitrage with Options and Futures
Volatility arbitrage takes advantage of disparities between the implied volatility (from the prices of the option) and the realized volatility (the one observed in real markets). The trade is in and out of options depending on whether professional traders feel that the implied volatility has been underestimated or overestimated.
The directional component is hedged using the index futures. The positional view is then left open for speculation on volatility. Suppose the trader believes options are underpriced on the basis of implied volatility. In that case, he purchases options and uses futures to neutralize delta risk. If the realized volatility turns out to be greater, the options appreciate, giving rise to profits; regardless of the direction of the index.
Conclusion
Less familiar option techniques in trading, such as ratio spread, calendar spread, gamma scalping, diagonal spread, synthetic position, iron fly, and volatility arbitrage, indicate that professional traders have tended to go beyond the most simple straddle-and-put strategies.
