Never sell options without hedging them
Options, both call and put, are probably the only instruments that price in the emotions of fear, greed and hope that rule the equity market at any given point. The rise in open in interests, or implied volatility, is the sum of the emotions prevailing on the Street. As always, last 12 months saw all these emotions visiting the market time and again.
The next 12 months will also see the same emotions visiting the market at regular intervals. Accordingly, traders have to employ strategies depending on the underlying market trend. But one strategy, or what we define as a constant strategy, for the next one year will be not to sell unhedged options, both call and put, with the hope of collecting premiums. True, options selling has a higher probability of making money than options buying. But selling options, that too unhedged and out-of-the-money, should be done only by professional traders, who spend all their time in the market.
The next 12 months are going to have events that will bring down the market close to its long-term support ranges. The worst part of the derivative market is that when the market is close to its resistance level, it creates upbeat sentiments that make it easier to sell put options. When the market is close to its low, the easiest trade appears to be to sell call options. But derivatives are instruments for hedging and reducing risk and not speculation, but unfortunately, in the market, these have become tools for speculation. When speculation is the objective, the end result is loss of trading capital.
For the next 12 months, a Nifty strategy that will yield results would be selling of straddles, with both ends of the trade being hedged. Covered call, where a range-bound movement leads to slightly higher returns, would probably be used again over the next 12 months. Also, when there is absolute panic in the market, when news flows make it appear that nothing is right, just take exposure through call options. Also, when everything appears to be going fine, use put options to cover the inherent optimism.
The Bank Nifty will be volatile, but for a short period. After a sharp dip, the index would likely inch up to recover all the lost ground. So, the best strategy on the Bank Nifty would be to trade once in a while with covered call and look for opportunities to buy put options.
Also, an opportunity would come in IT space when the quarterly numbers for large IT firms are announced. The guidance from most large-cap IT firms had not been encouraging and most of them have guided for slower growth. But many stocks have corrected, thankfully, to more realistic levels. Over the next 12 months, there would be phases when IT stocks would outperform when other sectors correct. So, covered call strategy should be used to trade in the IT index.
Rajiv Nagpal