A key purpose of derivatives instruments is to give a protective cover to one’s trade against event risks. Unfortunately, in the Indian market, derivatives have been used more as instruments to bump up one’s speculative trades. This week, which carries an event risk, offers an opportunity for traders to use derivatives as a cover. On Monday, the market is sure to react to the exit polls. Since the exit polls are not showing what Dalal Street had been looking for, probably we might see a gap-down opening. Rather than reacting to exit polls and getting panicked, traders should wait for the actual results.
Since valuations are still high, it would be better to hedge long positions by buying some put options. But remember that that market is in the habit of discounting things much in advance. So if the actual results prove exit polls right, we probably might see more decline in the index, but that would not be a signal to take short positions, but probably to cover short positions and book profit.
Elections, and specially state elections, could impact the market for just two days. Rather, the market would be looking more at global developments. Similarly, even if the state election results come in line with Street expectations, its impact would only last two days. The market would eventually run on corporate earnings and liquidity.
So, traders would do better if they use the first three trading sessions for hedging, and after the dust settles, use the next two for taking fresh positions.
The Bank Nifty would largely follow the Nifty trend, but overall it may outperform. Hence, traders may adopt the covered call strategy on the Bank Nifty and in some private banks in the latter half of the week. Most private sector banks have outperformed in the last three months of corrective movement. Some have even hit new 52-week highs. So traders may keep an eye on these stocks with the objective of either taking a covered call or buying at-the-money call options in the second half or when the market panics.
Most IT stocks witnessed correction last week, mostly as sideways moves, except for one session in which the Nifty declined sharply. Overall macro-formations on these charts show they might still stay in a broad range. Since the rupee is likely to stay in a range, very likely these stocks would follow a similar trend. So covered call strategy would be a better option in these stocks. Also, traders should not take aggressive short positions on days the IT stocks correct. Reason; the decline in these stocks could come more from profit-booking than any fundamental change in the sector. Profit-booking correction tends to be short-lived.