The profit potential of options is enormous. You can experiment with various trading strategies to make money in different market conditions, such as neutral, bullish, or bearish. The F&O market offers options in different lot sizes, underlying assets, and, most importantly, time duration. Since options contracts are subject to time decay, the concept of time becomes critical. Given this, the following article will present long-dated options in depth.
What are Long-Dated Options?
Long-dated options allow you to trade contracts with maturities ranging from nine months to three years. It allows you to mitigate risk if the market or stock becomes overbought in the future and you anticipate a correction. Long-dated call options usually expire on the fourth Thursday of the month; if the expiry date falls on a public holiday, it is settled a day earlier.
How does Long Dated Option work?
Long-dated options are identical to monthly options with differences in the time duration. Positions in such options are usually taken to replicate the exposure of index futures.
Suppose you are bullish on ABC Ltd. shares that are currently trading at Rs 100. If you buy 100 shares of ABC, the total cost would be Rs 10,000. In this case, your risk and reward potential are both higher. To mitigate the risk, you purchase an in-the-money (ITM) call option with one lot of 100 shares and a total contract price of Rs 10,000 (100 × 100) with a one-year expiry. The total premium you pay, in this case, is Rs 8,000. (Rs 8 per share). Your profit potential is unlimited in this case, and your risk is limited to Rs 8000.
Considering the above example, if your opinion turns bearish, you may purchase the ITM long-term put option instead of the ITM long-dated call option.
Characteristics of Long-Dated Options
Long-dated options come with distinct features:
- Predetermined Strike Price and Lot Size: These features help traders mitigate risks linked to time-related fluctuations.
- Minimum Nine-Month Maturity: Long-dated options typically span at least nine months.
- Limited Benefit if the Market Rises: While they safeguard against market declines, they may not yield substantial gains if the market surges.
Strengths of Long-Dated Options
Why should you consider long-dated options? Here are some compelling reasons:
- Risk Mitigation: Long-dated options reduce the risks associated with standard options trading by allowing you to hold onto the asset for a longer period.
- Diversification Opportunity: They provide a safe way to diversify your investment portfolio.
- Flexible Expiry: With extended expiration times, you can assess the market and trade when conditions are favorable.
Categories of Long-Dated Options
Long-dated options are typically categorized into two types:
- Call Options: These are available to buyers and allow them to profit from upward market movements. Buyers can purchase the underlying asset at the predetermined price, regardless of market shifts.
- Put Options: Sellers can benefit from downward market trends with put options. Sellers can still sell the underlying asset at the predetermined price, irrespective of market fluctuations.
What are the benefits of Long Dated Contracts?
- Diversification: Long-term options allow you to diversify your portfolio. This contract can be traded with underlying assets such as commodities, stocks, currencies, or other asset classes.
- Risk: This derivative allows you to protect your holdings if the market is in an overbought zone, and there is a chance that it will fall to correct the imbalance.
- Cost-effective: These contracts are available for a small premium. You can leverage 10-20 times the contract value with a small capital outlay.
What is the difference between Long-Dated and Short-Term Contracts?
|Parameters||Long-Dated Contracts||Short-Term Contracts|
|Duration||Their maturity ranges from 9-36 months.||They are available for a duration of fewer than 3 months. You can find weekly and monthly options as well on the market.|
|Costing||They are a bit more expensive than other options.||They are cheaper than long-term contracts.|
|Impact of time||They do not lose much value due to time decay. The risk here arises from leverage, which may magnify losses.||They become less appealing as the expiry date approaches while increasing counterparty risks.|
|Trading style||American & European||American & European|
Long-Dated Options in the Indian Market
In the Indian market, long-dated options are known as ‘Long-Term Equity Anticipation Securities’ or ‘LEAPS.’ These publicly traded options contracts share the same extended duration, usually over one year but less than three years. However, there’s a catch: LEAPS are only available for the Nifty50 Index, and their returns may not match those of riskier short-term contracts. While long-dated options see extensive trading in the US markets, their reach in the Indian market has a unique landscape.
In addition to long-dated options, there’s a range of other options strategies worth exploring, such as the iron condor, butterfly spread, condor spread, diagonal spread, and calendar spread. Each strategy offers a unique approach to navigating different market conditions, but they also carry their own set of risks and complexities.
Long-dated options are ideal for diversification with a small capital outlay. It protects you from any potential upside movement if the underlying asset is overbought.
Buying long-dated call options allows you to benefit from a positive, long-term outlook on an asset without the full investment. It grants you the right, but not the obligation, to buy the asset at a fixed future price, limiting potential losses to the premium paid. It’s also useful for hedging against a short position in the asset or related assets.
Short-dated options expire in less than a year, while long-dated options have an expiration of one to three years. Short-dated options have lower premiums and quicker value decay (theta) as they approach expiration. Long-dated options have higher premiums and slower theta, making them better for long-term views or hedging against short positions.
Holding a long option means you own or have purchased an option contract, either a call or a put. A long call grants the right to buy the underlying asset at a set future price, while a long put provides the right to sell at a predetermined price. You pay a premium to acquire a long option and can profit if the asset’s price moves favorably. You can also sell or close the option before expiration to lock in gains or losses.
The long-dated call option strategy is bullish and involves buying a call option with a distant expiration and a strike price at or slightly above the current asset price. This strategy aims to profit from a sustained asset price increase over time while capping potential losses at the option premium.
Disclaimer: Investments in the securities market are subject to market risks; read all the related documents carefully before investing.