Stay hedged under all circumstances

Last week really tested the guts of derivative traders. The volatile week rewarded only traders who had the courage to bet against the prevailing market sentiment. When the market was moving upward, if a trader had taken a contrarian view and bought put options, he would make gains and vice-versa. The tricky thing is, before trading on the Nifty, one needs to decide what kind of market are we in; bullish, bearish or range bound? In all these phases, the market can be volatile.

The issue is that the market witnessed seven to eight per cent correction from the recent highs. In a bullish market, such corrections are common and the indices tend to move up soon after such corrections, thus, heightening the volatility levels. So, as a principle, traders use options to hedge in a volatile market and in any case, do not sell straddle or strangles. But at this point in time, we would suggest that traders should look to buy strangles and take advantage of the volatility. One way to do this is to take the combined value of strangles and when volatility pans out and the trade is giving a short-term return of 25 per cent, just take it and get out.

A trap in such a market is that when indices are rising, traders form target levels on an index to close their option trade. Most of the time, the target level never comes and the trade is not settled in profit. If a trade is entered for hedging, then keep it till both the legs of the trade are over. But if a transaction is made for trading purposes, then have a defined profit target and close the trade when it is achieved.

It is better not to enter into many trades now, as the market has to still decide on its direction and set the boundaries for itself. Also, given that overseas markets are setting the trend for our market as well, it would be worthwhile for a trader to do a small and short trade against the market trend. Especially, have some put options when the market is moving upward. Since the market tends to fall easily, short-term buying of put options may give a return commensurate with the risk taken on the trading capital.

Two banks have declared their results after the close of the market hours on Friday and these are nothing to write home about. So in the first hour, we might see some negative reaction of that on the Bank Nifty. If there is a recovery in large-cap banking stocks after that, traders can look to buy Bank Nifty and individual bank stocks for long trade. If there is no major negative reaction by the end of the day, traders can think of buying call options of the Bank Nifty for trading purposes.

The IT stocks have seen a minor correction and the trend may continue. But having some IT stocks in the trading portfolio is necessary for traders as long as the market conditions are volatile. But one’s exposure to IT stocks should not be high, as these stocks may also see underperformance at some phase.

Rajiv Nagpal