Just two days before the expiry of the May series, the market suffered a major setback as the indices slipped more than 3 per cent in a single trading session. The frantic pace at which the out-of-money put options were being purchased was an indication of the strong fear that had gripped the market after it broke its 200-day moving average (200 DMA).

We have been writing in this column that any breakout has to clear some filter levels before it assumes any meaningful significance. We would continue to maintain that while breaking of any long-term moving average is a bearish sign, taking a huge position just on the basis of a monetary breakout is not advisable, given the fact that overnight developments in western markets have the potential of changing scenarios in Indian as well as other emerging markets.

There are phases in the market when confusion reigns supreme. It is better to go for smaller trade keeping a wider stop loss rather than a large bet with a small stop loss as high volatility can take the trade out. In such volatile times, when chances of a strong southward movement are very high, investors should have minor protection in the form of out-of-money put options in their portfolios. If, as an investor, you are not keen to spend money to buy put options, you may sell extreme out-of-money call options, which are above the strike price 5,400, to finance the buying of these puts.

With a new series of derivative contract kicking off and the possibility of a sharp drop in the Nifty still very high, aggressive traders can buy an out-of-money put option at strike price 4,800, which is now quoting at Rs 60. A minor slip in Nifty is likely lead to a sharp rise in the price of this option as 4,800 is a major support for the index.

Whether the index dips below 4,800 by the end of the June series or not is a different issue, but the fear of volatility itself can be an opportunity for option traders to earn good returns. For straddle writers, a straddle at strike price 5,000 can be a good strategy. The combined premium collected from this trade is Rs 265. The trader will have breakeven till 5,265 on Nifty in the upward direction, which is very close to its significant resistance level of 5,250. In the southward direction, the trader will not incur any loss till 4,735.

But this strategy should be used with the caveat that in case Nifty closes below 4,800, the trader should be ready to cover the put option and book a minor loss. zz

rajivnagpal@mydigitalfc.com