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Nifty closed above 11,000-11,050: Is it a breakout or another gyration?

Situations like these where there is strong consensus seem to have been built against the range breakouts, trading against the tide for that minor possibility of a very big move becomes very difficult

SHUBHAM AGARWAL | 15-Sep-19
Reading Time: 3 minutes

After an aged consolidation where there are already three-four gyrations within a trading range, there comes a time when it feels mature.

The breakouts from these matured consolidations though are tough to time as what it looks like a breakout could just turn out to be yet another gyration.

As the market has been keeping us on the edge since sometime now, where every time there seems lack of just one push that could lead to a big move unfold.

Situations like these where there is strong consensus seem to have been built against the range breakouts, trading against the tide for that minor possibility of a very big move becomes very difficult. Especially, after a couple of failed attempts.

To keep trying to trade a possible breakout, one needs to resort to a strategy in options specially used to trade either side volatility.

The situation we have at hand is expecting either a big move upon crossover of the known hurdle or similarly fierce if not equal in magnitude opposite move in case of a failure. This gives limited probability to the underlying meandering around the same level for a long time.

We can revisit one of the best strategies deployed in times of expected volatility, of Back Ratio Spread. Here, considering we are at the upper end of the recent range, if there is an expectation of a breakout with an equal possibility of a failure, we would be better off trading it with a Call Back Ratio spread .

The trade is simple we need to Sell a Call of the strike closest to the current underlying level and Buy not 1 but 2 Calls of a higher strike Call.

What this ends up doing at the beginning is it reduces the premium outflow considering the Higher calls cost lower than the Call of strike close to the current level.

Now, for the outcome, in case the breakout does come along, the Call sold does start bleeding but after a brief move compounding impact of the Calls come into play giving 1 Call against and 2 Calls in favor of our pay-off.

On the flip side, if there is a failure, Call Buyers would start bleeding. In times proper strike selection could actually bring in positive pay-off in case of large opposite move, making us a winner in case of a Head or a Tail.

The only move that could create negative pay-off is if the underlying stops and does not move. Hence, the trades shall be taken with a time stop loss of two-four sessions.

In case if the exit is not triggered within that time frame, exit the trade and wait for another trigger. This strategy costs you dear in terms of time with 2 Options Long Vs 1 Short.

Same as Calls we can execute this trade for a possible breach of support with a Put short in the strike close to current underlying level and 2 Longs in lower strike Puts. The mathematics still remains the same of profitability in either side volatility.

Obviously, the move down here would be potentially much more profitable. However, there is a caveat, the attraction of this trade setup starts to fade as we go close to the expiry, hence advisable to avoid this trade in the final week of expiry.

In such a situation, simple spreads would do as the premiums must have come off due to the time value decay element.

Molding Options and non-linearity of its pay-off could not be better utilized than in trades like Back Ratios. Be vigilant of the limitations of it and make the most of any possible Volatility with a directional twist.

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SHUBHAM AGARWAL is a CEO & Head of Research at Quantsapp Pvt. Ltd. He has been into many major kinds of market research and has been a programmer himself in Tens of programming languages. Earlier to the current position, Shubham has served for Motilal Oswal as Head of Quantitative, Technical & Derivatives Research and as a Technical Analyst at JM Financial.

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