Wait for the dust to settle first

Tags: Stock Market
It is very rare to see huge open interest in extreme out-of-money options. While Nifty is still below 6,300, the call option at strike price 6,600 from the December series shows large open interest positions. Somehow people expect Nifty to see a sharp directional move after the election results for the five states are declared, and huge open interest has been built into these out-of-money options in anticipation of such a move.

But there is no guarantee that simply because such a movement took place in the past, the same will get repeated in future. In fact, it is more likely that after an initial reaction, both the broader market and Nifty will move toward their recent mean and correct southward instead of witnessing a strong gap-up opening and a stronger move up from there.

In such a case there is no point in going for an extremely speculative trade just because the amount involved is small.

While this column is about derivative trade, it is not the place to talk about investing is stocks. But we are still tempted to make a suggestion to the traders who buy extreme out-of-money options in the hope of making a killing from an event-based movement. If a trader spends Rs 20 to buy an extreme out-of-money call option in the hope of volatility earning sharp gains, he can invest the same amount in a beaten-down stock of a reasonably good company, which at this point of time can be found in plenty, and increase the probability of making better gains over a period.

Yes, this gain is not going to come overnight, as can be the case with options. But options are instruments to be used sensibly for hedging and trading, and not for speculation.

As for our trading strategy for the next few sessions, we would suggest traders to continue with a covered call strategy for largecap stocks, especially from the defensive sector. A number of defensive stocks have been correcting over the past three months due to profit booking. In some cases, the correction has been in the form of a sideways movement with a high probability of an upward breakout.

In such cases, the covered call strategy will be the best option, as it is very likely that these largecap stocks will either gain or stay in range-bound mode as Nifty consolidates, and there is no better way than a covered call strategy to capture this trend. In case of Nifty we would recommend traders to wait for the kneejerk reaction to be over and then go for a trade, not just in Nifty futures but also in options.


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