How to trade options effectively in consolidation?

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Traders always like Trending Markets. However, every once in a while, there comes a situation when the market as a whole represented by the broader indices, runs that extra mile. A move that actually takes the stocks and indices little too far too soon.

While we are not one to judge what’s too far, but we do come to know about it when many stocks and indices start gyrating within a range. Current situation is no different with Nifty circling around 11,000-11,400 range roughly.

Being an option trader, one thing is for sure that apart from the direction of the move we are always worried about the speed of the move. Consolidating markets kill this as for a directional trader a target achieved today is always more profitable than the same achieved tomorrow.

Let us discuss how to trade options when these targets at times do not even come along and even if it does, it comes after a fairly longer time. All thanks to consolidating market, we may face this situation. Following are some useful tricks and trades that I fall back on when such a situation arises.

1. Reduce your trading horizon:

Consolidations have a habit of minimizing the size of the directional moves along with their longevity. So, first thing that could help is to find a trading moves that has visibility of achievement during a single day. Now, with a smaller move the profits could also be minimized. Solution to that is the strike selection.

While trading a Call option try and select a strike that is lower than what we would have selected in normalcy and likewise select a relatively higher strike on Put. By going deeper in the money like this the profits could go higher at the cost of some profitability (returns). However, this will not be so painful if we take the fixed transaction costs into account.

2. Trade beyond a day only through spreads:

In case one analyzes a trade set-up and comes to a conclusion that the move may take more than a day to materialize then take the spread route instead of buying a single option. Along with buying a Call sell a 2-3 step higher strike Call and along with buying a Put sell a 2-3 step lower strike Put. This strategy could minimize the returns but safeguard against short lived moves and time-consuming moves.

3. Introduce Prudence around Edges:

After a couple of gyrations, it becomes clear that the market is in a range. There could be tens of such gyrations or this one could be the last one. Rather than predicting that one should raise the prudence level. If we are rising and we see the indices around the levels from where it has revered multiple times recently, book profits and get out of a bullish trade. In case there are no existing trade open right now.

Either wait for a break out to happen and then participate small with a single option intraday trade. For brave hearts in case weakness is sensed after a move up to the upper bound of the range, one may even consider buying a Put and likewise buying a Call around the lower bound.

Finally, always remember that with multiple strikes and expiries there always lies a profitable strategy to trade any speed and direction in the underlying. So, let us use all the available options optimally and beat this consolidation effectively.

(The author is CEO & Head of Research at Quantsapp)

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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