Stay bullish, but stay hedged
The market is going into the budget week with a fair degree of optimism. This was more than evident from the way bears covered their short positions on Wednesday and the surge seen in open interests. On Wednesday, the expiry day of the January series, call options of the February series saw a huge build up of open interest, especially, out-of-the-money call options were being bought in a frenzy towards the last hour of trade.
A trader should always check the trend in open interest before an event, since the market reaction to the event would depend on how much of it has been discounted by the Street. If everyone is going long into an event with the intention to buy after the event it displays a sense of uncertainty in the market. In such cases, if the event does not pan out as the market has expected, strong unwinding pressure would emerge.
From the way put options had panned out, it seemed these options were sold rather carelessly. Prices of at-the-money put options from the February series were extremely low compared to the previous months. Regardless of Nifty’s post-budget direction, or speculating about its possible course, traders have to strictly desist from selling put options from the February series. However strong the bullish sentiment on the Street, no attempt should be made to make money by selling at-the-money or out-of-the-money options, especially by non-professional traders, because it involves unlimited risk.
We would still stick with the bullish to range-bound strategy on the Nifty along with the covered call strategy. or buying at-the-money call options. However, this time, given that we have the Union Budget on Wednesday, hedge your long positions by buying some put options, which are anyway not costly now. So, traders may look at buying Nifty futures and at the money put options from the February series simultaneously. Also, just before the budget, take some exposure to out-of-the-money put options to hedge the investment portfolio.
Macro-formations on the Nifty are still positive and the index has crossed some short-term resistance-giving averages. But the index’s strong rise was more from short covering than a build up in fresh long positions.
Trades on the Bank Nifty should be done only after the budget is announced, as any post-budget trend would be strong and sustained. If the budget is appreciated by the market, the banking sector would see heightened activity, if not, unwinding and build up of short positions would emerge. In either case, Bank Nifty will capture the maximum attention.
Another trade that is not specific to any sector but can be done around the budget day is to buy put options in individual stocks, especially in under-performers of the last six weeks. All these stocks would be prone to further correction from unwinding of positions and selling in the cash segment, and hence, could fall much more than the index. Since many options in stock futures are not liquid, put options from the Nifty should be used to hedge stock futures. Even if it is not a perfect hedge, having every long position hedged is needed at this point.
Rajiv Nagpal