Time to focus on stock options

While derivative instruments are always good hedging tools for traders, they also suit retail investors during the earnings season. So the latter can  follow some of the trading strategies suggested for traders this time.

As we have moved into the earnings season, traders will find derivative instruments useful in hedging their exposure to stock futures. But traders are reminded not to take too much exposure to the Nifty in the current earnings season. In normal times, the results of large-cap companies have a strong influence on Nifty movements. But this time, it could be different, except in the case of banks. Rather mid-cap results are likely to drive the underlying sentiment of the Nifty.

Given that the results coming up over the next one month would be reflecting one of the most tumultuous quarters in the recent past, the numbers will be a reflection of how good or bad companies had been in managing volatile situations. Some companies are surely going to be exposed, but if their influence on the broader market sentiment is too negative, that may trigger some unwinding even on the Nifty. So, beside the absolute levels of the Nifty, traders have to keep an eye on the broader market breadth, especially if they are taking overnight positional trade on the Nifty.

As for Nifty strategy for this week, take long positions in Nifty futures and also buy at-the-money put options. Indices had been trading in a range for a long time, but they don’t tend to stay like that for such a long period. Our base case is that there is a higher probability of the Nifty witnessing an upward breakout. So, long positions in Nifty futures could be a good strategy, and it would be better to hedge them with put options. At this point, only a small portion of the trading capital should be employed on futures, but more capital can be deployed on stock options, as there are higher chances of short-term gains in them.

Traders buying both call and put options in anticipation of volatile movements should look at the cost of buying the straddles. The cost of straddles is high near the result dates. So if the straddle cost is higher, it would be better to take exposure to stock futures and create a perfect hedge by buying either a call or a put option.

Coming to Bank Nifty, private banks continue to show strength, as many of them are forming new highs. At this point, there is high probability of the Bank Nifty outperforming the Nifty. In this case too, any long position should be hedged. In the PSU banking space, traders can look at buying call options because if a PSU bank manages to show that the worst is over for it, in all probability, its stock would see a sharp upmove.


Rajiv Nagpal