Options for equities as helmets for daredevils in time of stock market crash

Often times in the midst of a highly volatile session the market presents us with great anomalies. Such anomalies generally are short-lived and a corrective course that runs within a session or two would bring in swift opportunist gains.

  

The genesis of the Futures & Options (F&O) is into risk management, more so into the transfer of risk. Let us today discuss how these instruments, especially Options with its non-linear payoff can come in handy.

Often times in the midst of a highly volatile session the market presents us with great anomalies. Such anomalies generally are short-lived and a corrective course that runs within a session or two would bring in swift opportunist gains.

Over course of my trading life, I have had 3 such different types of situations, where it is too lucrative yet too dangerous to take a trade.

Where it’s like trying to fetch treasure out of a snake pit. All we are adding here is a pair of bite proof gloves in Options so that treasure or no treasure, won’t risk our lives.

Case #1 Stock has fallen 30-40-50% … good opportunity to invest for my bottom fishing friends

Here the investor is attempting to catch a falling knife. While there is a possibility that the stock would turn itself around immediately and pivot back to a more reasonable damage, equal chances are that there could be much more left to lose.

Relief comes in terms of Buying a Call. Instead of buying a stock at 100 buy a 100 strike Call. If the view is right, one would get all the benefit.

But, in case things were to deteriorate further from there all that is at stake is the Call Premium. Essentially, a cost paid to get the pair of gloves. On a later date when expiry nears the same can be converted to delivery as the storm calms down.

Case #2 If it has fallen so much at least there will be a recovery if not today maybe tomorrow

Holders of similar view as Case #1 but the class of participants here would be Traders. While the higher premiums are justified in the volatile times, it would ruin risk-reward for traders, who would want to get rid of the position as soon as a day or two if the stock pivots towards to parity.

In such cases, more often than not the premiums are up across strikes (EG 110 Call of Rs100/- stock would be trading at 15 in volatile times instead of 5 in normal times).

To counter this especially when one wishes to get rid of the position with mildest of recoveries. Pair up the Call Buy with a Short position in a few strikes higher call.

While the Call sold would cap the profits, it would give that much-needed funding when the premiums have soared multifold.

Case #3 abrupt move for an Investor Holding stock for Long Term

This is more a wealth preservation technique, instead of a wealth creation. I know the investors would not be tracking the stocks on daily basis, but it wouldn’t hurt to have an alert mechanism in place. (not that difficult in this digital era).

Just a simple drawing of attention would do when the stock starts behaving out of ordinary on the lower side. In such a situation, when there is an above average move Buy a Put Option just till the price stabilizes and shows you signs of firm ordinary behaviour. It is sort of buying medical insurance at the first sight of health irregularities.

God forbid if anything unfortunate were to happen, the pockets are not drained. So, gain all there is to gain if you win but using Options in turbulent times do not lose if you lose.

MORE WILL UPDATE SOON!!

Top lessons from Friday’s market crash and the swift recovery

Indian economy has been on a path of recovery over the last four quarters. There has been a broad-based improvement in growth suggesting tapering of GST and demonetisation disruptions.

  

The current market volatility isn’t accompanied by a live event so all sorts of conjecture on the state of the market are possible. It’s very hard to ignore a high decibel noise and focus on long-term. But here is how I see it:

a. Fake news is real. Do not alter investment or trading decision without fact-based analysis. Cheap doesn’t necessarily mean quality.

b. Avoid bottom fishing or selling based on forwards and rumors. Focus on business which can deliver earnings growth with strong balance sheets.

c. Leverage positions in F&O have to be sized correctly. Smaller positions for bigger moves is ideal when volatility rises. First time traders and investors should not be exposed to the volatility of derivatives.

d. Bear and Bull markets do cause prices to over and undershoot. Remember patience is a great virtue in markets and as numbers improve markets will come back.

What’s concerning?

A) Short term triggers – There were few short Term Triggers which caused Today’s rout.

RBI’s instructions to Yes Bank to replace Rana Kapoor as CMD put a lot of stress on the bank as well as weaker peer set across banks and NBFCs. While the change in leadership could be challenging for Yes bank to maintain its growth momentum and manage the balance sheet quality, generally tight liquidity conditions indicated by tightening yield put pressure across the sector. DHFL and Indiabulls Housing Finance were the other prominent sufferers.

The uncertainty surrounding the future of IL&FS and therefore liquidity conditions are souring sentiment. Though these issues appear to be transient they can be a source of significant volatility in the short term.

B) The macroeconomic landscape remains challenging. India’s external positions remain a key source of trouble for the rupee and interest rates. Pressure on India’s CAD due to stubborn exports and exuberant imports coupled with a lull in FDI/FII flows, a stressful dollar liquidity scenario is emerging. At 8.2% 10-year yield RBI may be constrained to raise rates to fend the rupee as well as contain the rising inflationary tide.

C) An intensifying dollar liquidity vortex is squeezing emerging markets one after the other. US FED, US Treasury and Corporate action combined together is likely to remove nearly $1.12 trillion in Dollar liquidity in 2018. This would keep weaker EMs on the edge.

D) Trade wars which have been pure political rhetoric till now but with $200 billion worth of imports duty on China lurking it may become a stress point.

The silver lining 

A) India’s economic growth is reverting to normalcy although many challenges remain. The current weakness in rupee is a way of markets to self-correct. Once this round of weakness is over and stock valuations become attractive and another round of opportunities will emerge.

B) The reflation of the Indian economy, which is underway, will lead to another secular trend in India’s consumption story. Indian economy has been on a path of recovery over the last four quarters. There has been a broad-based improvement in growth suggesting tapering of GST and ‘demonetisation’ disruptions.

C) Government expenditure has been a source of support for the economy and is likely to be so in a pre-election year.

D) The best news is perhaps on the earnings front where profit growth in Q1FY19 (ex PSU banks) has been close to 20 percent and maybe a harbinger to better tidings as the IIP and core sector data indicates.

MORE WILL UPDATE SOON!!

Friday's crash signals time to 'hide in defensives'; Sun Pharma, Wipro, Dr Reddy’s make good bets

Our strategy should be to hide ourselves in the defensive sector till the Nifty does not cross the all-time high level of 11,770.

 

In the past, the Nifty has a number of times witnessed a steep fall due to extreme sell-off because of unwarranted reasons. It is not new to market participants and instead of thinking and wasting time on what has happened, we should be focusing on the next strategy and learn from such falls and make the most of it.

Our observation has been that since the market has announced the GDP numbers (above 8.20 percent) it has been falling consistently. This is the best example of the famous quote, "Buy the rumour and Sell on the news".

In September so far, the Nifty has fallen 4.50 percent and the index heavyweights are down by nearly 10-12 percent, which is in tandem with the trend of the market.

However, we see that there is some serious damage while going through a stock-specific activity.

The lowest level of Friday is going to act as a major support level for the Nifty. It was the 50 percent level of the entire rise between 9,950 and 11,760.

We must give due weightage to the 50 percent retracement ratio and that is the major reason that we consider it to act as a trend decider level for the market in the future.

If we see increased volatility and further weakness below 10,865 on Monday then one more round of selling cannot be ruled out to levels that could either be 10,650 or 10,550.

Being in an uncertain market, instead of knowing what could be the next level we should try to understand what experts do during such market sell-offs.

Our strategy should be to hide ourselves in the defensive sector till the market does not cross the all-time high level of 11,770.

The reason — currently that the market is in an uncertain zone and due to a number of events which are lined up (US Fed meet/RBI meet and quarterly numbers) there could be increased volatility. These sectors trend higher during uncertainties.

While looking at the current statistics of GDP and the trend of the rupee, we suggest that one should look to add pharmaceuticals stocks over FMCG.

Technology stocks have already delivered eye washing returns in the past 12 months.

Taking a "Bottom Up" approach while selecting stocks from technology, and using a "Top Down" approach is advisable in pharmaceuticals space.

Technically, we like Sun Pharmaceutical with a final stop loss at Rs 550 and Dr Reddy’s with a stop loss at Rs 2,300 from the pharmaceutical space. On the higher side, we can expect 30 percent returns from current levels in both these stocks.

From the technology basket, we would stick to Wipro, which is entering into a multi-year breakout zone, keeping a stop loss for the same at Rs 300 on a closing basis.

Multi-year breakout formation in stocks generally offers hefty returns to investors. We expect Wipro to move to its all-time high of Rs 517 in the next 12 months.

MORE WILL UPDATE SOON!!