Stay with puts and diversify risk across sectors

Probably, every trader likes heightened volatility. But when volatility does come, they run for cover. Last week’s volatility caught even the best of traders on the wrong foot, especially traders who sell put options on the assumption that the Nifty cannot go downhill, especially around the time of expiry. But all of them had to bear the brunt of Friday’s decline.

Last week’s decline came about without any upheaval in Indian or international news. Hence, most traders were at a loss to foresee the decline. The extreme low prices of put options on Thursday were clear indications of over-confidence.

We expect this phase of volatility, with a bearish bias, to continue. So, as a first strategy, small traders should not take unhedged positions in stock futures and they should not attempt any trade that involves selling options, both call and put, for collecting premiums, since sharp moves could happen even after expiry is done and dusted.

Essentially, our strategies would remain the same for the next couple of trading sessions. Have put options, stay hedged on long positions on stock futures and take profit off the table, where available, on long positions. Covered call strategies suggested last week have stopped out, as the decline has taken the Nifty below its support levels. Traders who had covered their lower breakeven points by buying put option should continue with that and shift positions to the next series. For traders who are conservative and want to save their capital, stay out till the expiry of the September contract and then take hedged positions. If the market remains week for the next few sessions, the probability of which is high, then selling call options would appear an easy trade. But do not do it as that entails the high probability of getting trapped. If one wants to take short positions, sell futures covered with call options.

Another strategy traders can look at is to buy some out-of-the-money call options of bank stocks, as these stocks have been beaten black and blue and have reached oversold levels. For a limited risk trade, traders can look at buying call options with the intent to keep them till the end of the October series . A short covering bounce might happen in these stock, triggering a sharp rise in at-the-money call options.

Also, traders may look at buying some out-of-the-money call options in large-cap IT stocks, as the rupee’s weakness could lead to some up-move or hedging trade in IT stocks. This is a short-term trade.

Another trade opportunity may emerge in pharma and FMCG stocks. If the Nifty declines further, we might see FMCG stocks gaining weight, as September sales figures could throw some surprises. If the Nifty sees any sharp decline, traders can buy call options FMCG stocks, as some defensive money may get parked in this sector.

Rajiv Nagpal