Welcome to yet another important article reading the options trading strategy. We are going to learn about the first adjustment strategy which is called average out and don't quit before learning the tricks which I am going to tell you. I’m going to tell you something which I learned over the year because the common normal average out generally doesn't work and it increases your losses but if you are going to use my tricks, then it is going to work in a much better way and trust me it can help you to convert your loss-making position into profit-making positions but of course not always and you have to judge the situation and then only apply this adjustment strategy. So, let's learn about how to do average out.
I have explained everything about option strategy’s basic part article and we are going through the advanced part of options trading strategy. We have already covered the first can say step which is a market view, the second step that is about the entry or the strategy, and the fourth is an exit which we are going to discuss in the last. We are on the third step and the third step is adjustments and, in the adjustment, we are learning the first adjustment strategy which is called average out.
Let's understand the first important part is the logic of average out. So, logic is very simple. What we think that I’m talking about from the point of option sellers. Just you understand most of the time I sell options because selling options most of the time make money but sometimes, I do the option buying so almost 70 to 80 percent time, I sell options. Just 20 percent time, I buy options. I’m going to discuss when we come to strategies that when you should buy the options when you should sell the options.
So, here the average out formula, we are learning from the point of view of selling options because once you sell the option and the market move opposite, you like sold a call. When you sell a call, your simple thought processes are that market will not come at this point and I will keep the premium but as this market starts moving upward, your call premium doubles up and the mark to market start showing your losses. So, in that situation there are two options, first option if I feel that the market is just being volatile and it is not going to crack across this point because this point is a big resistance or support, then I can do the adjustments.
So, the first thing I told you logic is very simple is to sell another lot. Once my premium is double up or triples up so I can set my standard I suppose I sold a call option at rupees 10 and as soon as it becomes 20, I will sell another option another lot. So, what will happen, my cost will become 15 rupees and my average cost will become 15 rupees. So, you can say breakeven point will increase by five points, how five points, earlier I had 10 rupees right, so my breakdown was 10 rupees up but if I average out, my break-even doesn't increase by 20 right, it is 15 because 10 plus 20 divided by 2 become 15. So, earlier my breakeven was at 10 rupees for example now because my premium which I have received become 15 rupees average per lot.
So, my break-even becomes 15 which is five rupees more than the previous breakeven. So, I increase my break-even by five rupees. So, the logic is very simple that whenever the premium goes up and I feel that this is a temporary phenomenon, it's not like the market going or there's a rally or something happening, then only I should do the average out. So, every time, markets say go two times three times of my premium which I sold I can do an average out and I can hope that after that point, the market will go back and I will make a profit otherwise if I just don't do anything and suppose market stays at 20 rupees, for example, then I will lose 10 rupees per unit. So, for nifty I will lose 10 rupees into 75 which will become 750.
That much I will lose. But suppose I do the average out and the market stays at 20, then I will lose only 5 rupees but 5 into 150 become 750 because I sold two lots so total 150 quantity. So, that way even you calculate my losses won’t be that much, it will be slightly less maybe the market can come down to 15 rupees then I will not lose anything. So basic expectation behind the average out is the market is temporarily going up and it will come down. So, first I told you the logic. Average out is very simple. The logic is to increase my break-even point and the second important point is the situation right so what is the situation under which I should do the average output?
For any adjustment including average out, the simple understanding simple thinking is that the market is temporarily you can say volatile. It is not permanently moving up or moving down. So, there is no rally and there is no crash just temporarily it's going up. Now, on every expiry day, the options market becomes volatile because you understand if you have sold the options to someone else, then somebody has bought it right and if you are going into profit, the other person is going to be at loss. Now, you don't know that on the other side some big operator is sitting. So, what he'll do on the other day, he will just keep quiet but on expiry, he will start throwing up the prices so that he can scare away the option sellers and he can make the profit. I hope you learned something new about the option adjustments. In the next article, we will learn about the reverse average out.