Stock derivatives, such as call and put options, can be used in three different ways. First, for making hefty gains by taking low risk by buying call or put options. Secondly, to hedge the value of your stock portfolio against any major market slump due to an unforeseen event. And, last but not the least, to reduce the cost of holding and earn some returns on your portfolio by selling out-of-money calls.

Depending on your assessment of market direction, all the above three can be used at the same time. But in each case, the first and most difficult step is deciding on one’s outlook for the market.

Our view is that until there is any major negative development, the broader market is going to remain strong. However at the same time, we are going to see periodic declines in the market due to profit booking.

Under the circumstances, writing out-of-money calls could be one of the strategies that an investor may follow over the next few months to increase returns in a market that is likely to move up gradually.

As far as the short-term trend is concerned, the market is once again placed very close to its strong resistance area. Some events may take place and they have the potential of making the indices move sharply in either direction.

As we have been saying in this column, investors should use derivatives as a hedging instrument to protect the value of their portfolios during such periods. For traders, it is an opportunity to make sharp gains by taking limited risk. For an investor, we would recommend buying a put option at strike price 5,000, which is now quoting at Rs 42. As 5,000 is an important support level, a slip below this mark could lead to a sharp correction in some of the mid-cap stocks. So an investor with exposure to high-beta mid-cap stocks should buy this option.

As far as traders are concerned, we would suggest buying of call options at strike price 5,100, which are now quoting at Rs 98, and some put options for the same strike price at Rs 72. As the Nifty is likely to see a sharp increase in volatility, the price of either of them, call or put options, is going see a sharp increase. As the open interest is very high in this strike price, a covering in the option is going to give high returns to investors. As for traders, they should sell both the options at the same time in order to increase returns.