Zero-to-Hero Option Trading Strategy

In this article, we will discuss

• What is the Zero to Hero Strategy?
• A Closer Look at How This Strategy Works
• A Step-by-Step Guide to the Zero to Hero Strategy
• Actionable Tips to Improve the Trading Outcome
• Conclusion

Traders engaging in options trading need to be aware of the risk-reward proposition of each new position they initiate. This is because the options segment is a highly risky area of the financial markets — and some strategies are riskier than others. One such strategy with high risks and potentially high rewards is the zero-to-hero trading technique.

What is the Zero to Hero Strategy?

This is a strategy that aims to leverage the sudden price volatility that some options may experience on the expiration dates. To execute this strategy, traders buy out-of-the-money (OTM) options on the expiry date, expecting them to expire as in-the-money (ITM) options. This effectively means that the move from being zero contracts (with little to no profitability) to hero contracts (that offer substantial returns). Hence the name 'zero to hero.’

A Closer Look at How This Strategy Works

Depending on the strike price and how it compares to the current market price of the underlying asset, options contracts can be classified as:

• At the money (ATM): When the strike price is equal to or very near to the current market price

• In the money (ITM): When the strike price is less than the market price (for calls) and more than the market price (for puts)

• Out of the money (OTM): When the strike price is more than the market price (for calls) and less than the market price (for puts)

OTM calls and puts are generally priced lower than the other two types of options. Furthermore, as the expiry date approaches, options tend to lose value due to the effect of time decay. Together, these aspects make OTM options extremely low-priced securities on expiry.

However, if the price of the underlying asset increases sharply in the hours leading up to expiry, an OTM call option may become ITM or ATM. Conversely, if the price of the asset falls in the last few hours, an OTM put option may expire ITM or ATM. By purchasing OTM options at cheap prices on the expiry date, traders can profit from the sudden spike in value if the options become ITM or ATM at expiry.

A Step-by-Step Guide to the Zero to Hero Strategy

To implement the zero-to-hero options strategy effectively, you need to follow the steps outlined below.

• Step 1: Understand the Market Conditions

Start by evaluating the prevailing volatility levels and sentiment in the market — especially in the context of the underlying asset you want to trade. Higher volatility levels increase the probability of OTM options moving into the money.

Example:

Say the Bank Nifty index has been highly volatile in the days leading up to expiry. In that case, you may have the opportunity for a zero-to-hero Bank Nifty options trade. Similarly, you can also use other indices, stocks, currencies or commodities as the underlying.

• Step 2: Select the Right Options Contract

Once you know which underlying asset you want to trade in, choose deep OTM call options or put options that are trading at low prices, preferably as close to zero as possible. These options should have very little time to expire.

Example:

Say the Nifty index is trading at around 22,290 points. If you expect it to rise quickly on expiry, you could consider buying an OTM call option with a higher strike price of say 22,500 (trading at around Rs. 5). Alternatively, if you expect the index to fall rapidly in the next few hours, you could consider buying an OTM put option with a lower strike price of say 21,900 (trading at around Rs. 2).

• Step 3: Initiate the Trade

Buy the contracts chosen based on the expected direction of the asset movement. Limit your purchase to around 2-3 lots at most to cap the risk in the trade. The cost will be low because these options are out-of-the-money.

Example:

Say you expect the Nifty to rise. You may then purchase 2 lots of Nifty call options with a strike price of 22,500 and a premium of Rs. 5. This means you have a total outlay of Rs. 250 (i.e. Rs. 5 x 2 lots x 25 per lot).

• Step 4: Decide When to Sell

After you purchase the options, you need to closely monitor the market for any quick changes in the value of the underlying asset. This will help you decide when to exit your trade. Ideally, you should close the position when the options you purchased become ITM.

Example:

Say the Nifty index rises to 22,550 and the options premium for the contracts purchased rises to Rs. 75. You can decide to sell at this point.

• Step 5: Close the Trade

If the market moves in your favour, once you decide on the exit price, all you need to do is close the trade. If the market does not move as expected, you will have to let the options expire worthless. The loss will be equal to the premiums you paid for purchasing the options.

Example:

Let’s see what the outcomes may be, depending on how the market moves.

• Zero Outcome:

If the index falls to 22,000 and the call options expire worthless, your maximum loss will be equal to the premium paid, which is Rs. 250 (i.e. Rs. 5 x 2 lots x 25 per lot).

• Hero Outcome:

If the index rises to 22,550 and the options premium rises to Rs. 75, you can sell the options for Rs. 3,750 (i.e. Rs. 75 x 2 lots x 25 per lot). This will give you a net profit of Rs. 3,500 from the trade [i.e. Rs. (75 - 5) x 2 lots x 25 per lot].

Actionable Tips to Improve the Trading Outcome

If you want to improve the outcomes of this options trading technique and keep the risks to a minimum, the following tips may be handy:

• Assess the likelihood of the underlying asset’s price moving sharply on the expiry date.
• Be fairly certain of the direction of price change as this affects your choice of options — whether put or call.
• Ensure you choose OTM options on the expiry date.
• Timing is crucial in zero-to-hero trading as the price explosion typically occurs in the last few hours.
• You need to remain objective and calm about the volatility in the market.
• You must ensure you only use the capital you can afford to risk if the options expire worthless.

Conclusion

Zero-to-hero trading is highly risky, but when it is successful, it can be incredibly rewarding. To ensure that you do not overexpose your capital to risk, it is best to take a cautious approach when you adopt this trading strategy. If you are new to options trading or if your risk tolerance or capacity is low, it is best to consider other options strategies to leverage different market conditions.

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