Back to covered call with hedge

On Friday, when the Asian markets were trading in the red and the European markets had opened gap down, it was expected that the Indian market would also come under pressure. But the local market surprised investors by ending the day with a mere 14-point cut in the Nifty. This was an indication that while the rest of Asia was selling, short covering was lifting the market in India. This brought cheer to the community of call option buyers and contrarian investors. When the market rises on short covering, traders who had the guts to buy call options benefit. This is a call to the traders to use options and derivative instruments to take contrarian bets rather than speculative positions.

We would continue with the strategy of covered call on the Nifty and selling multiple straddles, with the lower end of the breakeven point being partially covered by buying out-of-the-money put options and far out-of-the money call options to guard against possible short squeeze. This short squeeze might get triggered if the crude oil prices drop further. The weightage of straddle trade in the trading portfolio should be kept low and increased if the Nifty stays in a range-bound mode for the next couple of sessions and should not be taken without covering the lower end of the trade.

Traders can stay with covered calls on the Bank Nifty as the index is once again making an attempt to outpace the Nifty-50 and is placed right below some of its important moving averages. If it is able to cross these averages in one or two trading sessions, we might witness a short squeeze.

It appears from the bank stocks’ movement that while major buying is not emerging, traders are wary of taking short positions, given that most banks had been floating around while other segments of the market were drowning. So, traders should go for covered call even in the PSU banking space, but be ready to see some mark-to-market losses before finally making returns. Also, on a day when private sector banks make a sudden up-move in early trade, traders can look to take an intraday long trade with a stop loss on the trade.

Another strategy traders can look at over the next couple of sessions is to take short-term exposure to some auto stocks. After receiving a round of beating, these stocks are showing signs of a short covering bounce or consolidation before another round of strong directional move happens. So, think of taking long exposure to them through call options. If exposure is made through stock futures, then remember to hedge them.

Ideally, traders should take exposure to various sectors instead of taking a concentrated risk, as sectoral divergence would increase going forward. While diversifying, traders may focus on large-cap stocks as hedges can be created on them easily.

Rajiv Nagpal