Keep Options handy when bargain hunting to avoid risk of reversal: Shubham Agarwal

Reading Time: 3 minutes

Heavy Selling in the market like one that we saw in the week that went by brings up two specific emotions. This is true especially when the indices have been ruled by the bulls in the recent weeks and months. One of the emotions is the sheer jitters it brings to the nerves concerning the existing long trades.

This is a feeling that we have learnt to handle. While the well tested and traditional discipline of defining and executing the stop losses would certainly avoid this, many of the not so frequently traders of the options also now know that at the first sight of fright buy a hedge. In this particular case to hedge existing long trades many would have resorted to this already.

However, many of us regardless of the fact that we are or are not holding on to existing longs get enticed by the comeback. These are the comebacks like the one that we saw on the last trading day of this week.

It may be some of the opportunities lost in the previous run or quite simply the correction in prices that the recent fall brought in, but it does bring in a second kind of emotion which is an Urge to Hunt for Bargains.

While this is not completely wrong, yet there remains a fair possibility that we have already had the run that was supposed to be.

Hitting a reversal after the run up from the serious low points of 7500 to the recent high in upwards of 11700 is not that unreasonable either. Such a situation makes this bargain hunting more of an adventurous exercise than a tactical one.

The best way to engage into any adventure is by investing into safety gears first. So that we get all the thrills without having to worry about dangers.

For Investors trying to fish in these shallow waters the strategy is simple. Try to find the stocks listed in the F&O segment so that options available. Strategy is simple. Buy the stock with quantity equal to the Lot Size and Buy a Put alongside it of a strike closer to current market price.

This strategy at a sunk cost of roughly 3-5% will keep the safety net ready beyond the cost of the Put below the strike price. Over the course of expiry if the Stock gives an immediate bump-up, which it could. Best example is Stocks bought on this Thursday and spiking on Friday.

The Put option gives a flexibility of booking part profits as well without having to touch the holding just by switching the Put option higher. This could increase the cost of protection a couple of percent higher but will eventually be helpful in case the spike ends up being a dead cat bounce in that tiny time frame.

For Traders, the best way to handle this is by refraining from taking any futures position. Just Buy a Call Option instead of strike closer to current market price. Once again, here the sunk cost of premium defines the maximum loss. Ideally this option is to take trades for a 2-4 trading sessions.

Even here, similar profit booking can be done if there is spike during the day or in following session. Just book profits in the Current Call Option bought and switch to a higher strike Call option closer to the higher price level at which the stock is currently trading.

Being wasting assets and considering the relatively smaller horizons of traders it may not make sense to hold on to them for the rest of the expiry.

However, if one does intend to create a position for a longer time horizon like the rest of the expiry, it is advisable to go though the spread route.

Buy a relatively (1-3 steps) higher strike Call option and simultaneously Sell about 3-4 steps even higher Call. The sensitivity to the immediate move may not match that of the single Call that could have been bought.

However, generally with about 4:1 kind of expiry pay-off, these trades are very attractive when it comes to maximum money that is at stake and handling the wasting asset characteristic of Options .

These are just a few ways, but there can be many more. The intent behind sharing these few examples is to help realize numerous ways in which the availability of options can help avoid undue risk while taking a rather courageous call within current uncertain times.

(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.

Learn and read more about hedging strategy from Quantsapp classroom which has been curated for understanding of option strategy builder from scratch, to enable option traders grasp the concepts practically and apply them in a data-driven trading approach.