Options Strategies for Event-Driven Trading

In this article, we will discuss

• What is Event-Driven Options Trading?
• 5 Options Strategies for Event-Based Trading
• How to Mitigate Risk in Event-Driven Trading?
• Event-Driven Trading vs Event-Driven Investing
• Conclusion

The financial markets in India have a busy event calendar with specific dates marking various events like earnings announcements, RBI’s Monetary Policy Committee (MPC) meetings, product launches, regulatory changes, political events, court rulings and sector-specific news. For the savvy retail trader, these events present excellent opportunities for implementing winning options strategies.

However, event-driven trading in the options market can be highly risky if you are not 100% aware of the risk-reward equation in every possible trade. So, you need to analyse your options strategies comprehensively before you implement them in the days before or after a specific event that could affect the options market.

In this article, we take a closer look at the meaning of event-based trading for options traders, how it differs from event-driven investing and how you minimise risk in your options strategies. We also explore examples of different options strategies for specific events that influence the F&O segment.

What is Event-Driven Options Trading?

Event-driven trading in the options market is a technique that involves implementing specific options strategies that are based on scheduled or anticipated events that could impact the prices of the underlying assets and/or the options contracts. Some examples of such events include regulatory decisions, company-specific news, economic policy changes or broader geopolitical events.

Events like these could lead to large price swings in underlying assets like stocks, commodities or currencies. Consequently, the options contracts of these assets are also affected by such event-driven price movements. You can capitalise on this anticipated volatility with the right options strategies. You can also use event-driven options strategies to hedge a position in the underlying asset market with a corresponding trade in the derivatives market. This helps you prepare for any unexpected price volatility.

The goal of options strategies based on specific events is to capitalise on the short-term price movements triggered due to the incident concerned. So, most strategies in this category have a fairly short-term outlook. The primary appeal of taking a position using options rather than the underlying asset itself is that you can gain significant exposure to price movements with a relatively small investment. Additionally, if you plan your options strategies well, you can also limit your losses to the options premium alone — thus ensuring your downside risk is quantified and limited.

That said, timing is crucial in event-driven options trading. You need to carefully analyse the event of an outcome as well as how the market may react to it. Incorrect predictions could lead to steep losses that are proportionate to the size of the position you have taken in the underlying asset.

5 Options Strategies for Event-Based Trading

With over 1,000 options strategies to choose from, you can undoubtedly find a variety of trading opportunities based on any event you anticipate in the markets. Here are 5 examples of some event-based strategies you can use in the options segment.

• The Earnings Straddle

The earnings straddle is an options trading strategy that can be particularly effective during a company’s earnings announcements. During this time, the company’s stock price may move significantly, leading to volatility in the stock options too. To set up an earnings straddle, you need to buy a call and a put option with the same strike price.

The expiration dates for the two options should also be the same — and should ideally align closely with the earnings announcement. It is best if the options expire right after the earnings date, so you can effectively capture the volatility stemming from this event.

Outcome:

When the earnings are announced, the price of the stock may rise or fall sharply. Depending on the direction of the price movement, you can exercise the call or the put option and let the other one expire worthless. Your losses will be limited to the total premiums paid, while your profits will depend on the direction and quantum of the stock price movement.

• Protective Put

Event-driven options strategies need not always involve all new positions in the market. You can also use this technique to modify or hedge existing positions ahead of an anticipated event. The protective put is one such strategy that can be crucial to manage the risk in any long position you already hold in a stock or underlying asset.

To set up this strategy, you should already hold a company’s shares or other assets like commodities or currencies. Thereafter, you purchase a put option on the underlying asset that you already hold. This protects you from any adverse bearish movements in the asset’s price. Alternatively, you can also set up a protective put by purchasing futures and hedging that position by buying a put option with the same underlying asset.

Outcome:

Say you hold stocks in a company. If you anticipate an event that could drive the company’s stock price down, like a negative earnings report or unfavourable court rulings, you can buy a put option on the company’s stock. If the price falls due to this event, you can profit from the put options strategy. If the price remains stable, you only lose the premium paid for the option.

• Calendar Spread

Since event-based trading is a time-sensitive technique, options strategies like calendar spreads can be extremely useful if you want to leverage the profit potential due to the passage of time. To set up a calendar spread, you buy and sell the same type of options, with the same underlying asset and strike price. However, the option you sell should have a near-term expiry while the option you buy must have a long-term expiry.

The near-term expiry should be closer to the event you anticipate. So, as the implied volatility of the contract rises, its value quickly erodes due to time decay. This means the option may expire worthless, so you can profit from the premiums on the option sold.

Outcome:

If the near-term option you sold expires worthless, you gain from the premiums. Alternatively, if you decide to close the position before expiry, you can buy it back at less than the price you sold it for, thus profiting from the difference. As for the long position, you can hold on to it if you expect the stock’s price over the next month or two.

• Iron Condor

The iron condor is an options strategy that is best suited for stable markets with low volatility. So, if you expect the price of an asset to stabilise after a major event or if you anticipate a low-volatility market in the post-event trading sessions, you can consider using this options strategy. To set up the iron condor, here is what you need to do.

• Sell an out-of-the-money (OTM) call option
• Sell an OTM put option
• Buy a further OTM call option
• Buy a further OTM put option

You should choose the strike prices carefully in an iron condor. The strike prices of the short positions are particularly crucial because you can only profit from this options strategy if the asset’s price remains within this range.

Outcome:

If the price of the underlying asset is not too volatile and remains between the strike prices of the two sold options, you can profit from the premiums earned (adjusted for the premiums paid for the purchased options). However, if the price rises above the short call’s strike or falls below the short put’s strike, you incur losses.

• Butterfly Spread

Like the iron condor, the butterfly spread is also an options strategy that is ideal when you expect a stable market following an important event. To set up the butterfly spread, you must initiate the following four positions in the market:

• Purchase one in-the-money call with a lower strike price
• Sell two at-the-money call options
• Purchase one out-of-the-money call with a higher strike price

This options strategy involves three different strike prices: a lower price, an at-the-money price and a higher price. You should typically use this strategy if you expect the price of the underlying asset to be around the middle (or at-the-money) strike price during the event in question.

Outcome:

If the price of the underlying asset hovers near the middle strike price, the potential for profits increases. The maximum profit occurs if the price is exactly at the middle strike price. However, if the price at the time of the event is well above the higher strike price or below the lower strike price, you will incur a loss.

How to Mitigate Risk in Event-Driven Trading?

Event-driven options trading is not without its risks. Since the market movement cannot be predicted precisely, the options strategies you implement may be favourable or unfavourable. So, to limit the downside risk, you can take the following measures:

• Use Technical Analysis

Use technical indicators that can help you assess the market sentiment surrounding an event. The Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), put call ratio and trading volume can all be instrumental in understanding the direction in which the market is moving.

• Implement Hedging Strategies

If you want to leverage the market volatility surrounding an event, you may be tempted to enter the options market without having a hedge in place. Such naked options trading can be highly risky, especially if you have taken a large position in the underlying asset. To avoid this issue, it is best to implement options strategies that have a built-in hedge.

• Limit Exposure

Another important tip to limit the risk in event-driven options trading is to focus on position sizing. Avoid taking large positions that focus only on a single event. This concentrates rather than diversifies the risk. On the other hand, if you only allocate a portion of your capital to any one event-driven trade, the risk is more manageable.

• Choose the Right Time Horizon

The expiration dates on the options you choose for your strategies must align with the time horizon of the event you want to leverage. On the one hand, you should have enough time to allow the event to unfold. On the other hand, you must be mindful of the impact of time decay on your positions.

Event-Driven Trading vs Event-Driven Investing

Although the two terms may be used interchangeably, event-driven trading is quite different from event-driven investing. The only common aspect, perhaps, is that both event-driven investing and event-based trading rely on specific events and developments in the financial markets. Here is how these two techniques are different:

• Objective

Event-driven investing aims to profit from the fundamental changes in a company’s value following a specific event. Such changes could lead to an appreciation in the company’s share value, thereby offering potential profits for investors. Event-driven trading, on the other hand, aims to profit from price volatility and market inefficiencies due to an event.

• Time Horizon

Trading is a short-term pursuit that takes into account price movements over a few hours to a few days, at most. However, event-driven investing is not focused on rapid short-term price changes. Instead, this technique relies on long-term changes in the valuation of a company, which is often triggered by a major event.

• Risks and Rewards

Event-based trading can be a way to earn quick profits. However, since it deals with short-term price volatility, trading can be highly risky too. On the other hand, event-driven investing is considered to be relatively less risky due to its long-term outlook. It is not largely affected by short-term volatility in the market.

• Analysis Required

To successfully execute an event-based trade, you need to rely on technical analysis and study market sentiment. But event-driven investing, which is commonly used by hedge funds and large institutional investors, focuses more on fundamental analysis and valuation of a company’s stocks or any other asset.

Conclusion

Finding the right options strategies for event-driven trading can be quite a challenge. Samco’s Options BRO — an industry-first options strategy builder — makes this easy for traders using the Samco trading app. If you have a demat and trading account with Samco Securities, you can access Options BRO free of cost. With just a few insights about the contract you want to trade, its expiration and your market outlook, this options strategy builder suggests the top 3 strategies for your risk profile — be it aggressive, moderate or conservative.

What’s more, you can also check out hundreds of other options strategies that align with your requirements. So, all you need to do is assess the market outlook accurately and choose options with the optimal time to expiration. Thereafter, you can implement even multi-legged strategies with just one click directly from the Samco trading app.

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