Option trading for range-bound market: Shubham Agarwal!

It is worrisome when the major index like Nifty is changed by a little over a percent in the last 3 months. The volatility has been there, but that too in a good 3-4% range. These are the times when a simple Buy and Hold strategy can get frustrating.

In such times of range-bound movement, especially, initiating a bearish trade after a big fall feels like going against the trend. The risk of indices and stocks getting back into the range is very high.

So essentially, we need a trade that does not hurt us if the very short-term trend ends right after we take the trade. At the same time, we need not miss the opportunity nor be too protective.

Detect a range-bound market with the following 3 characteristics visible in the equities market.

1. The Highs and Lows made a few weeks back have not been broken (and sustained)

2. Open Interest in Nifty Calls and Puts is almost equal (Publicly available information on NSE website)

3. India VIX has dropped in the last few weeks

As soon as it is established, we can treat and trade such market conditions like a range-bound market.

Trading Technique #1

Put a Butterfly in place in Nifty

Creating this strategy is simple. Sell Both Call & Put of a strike closest to the current level of the index. Being an index, it is likely to be less volatile, and liquidity is enough as well. However, since selling options has an unknown risk profile, we will add a couple of more options to this.

I always buy Protection. Along with the Sell Options, Buy a Higher Strike Call Option and a Lower Strike Put Option. An easy way to choose the strike is that the difference between the Buy strikes could be equal to the total premium received by selling options.

Example:

Index at 1000

Sell 1000 Call @ 50

Sell 1000 Put @ 50

Total Premium received 100

Buy 1100 Call & Buy 900 Put for Protection.

Maximum Profit would be the net premium received, and maximum Loss would be the difference between Buy strike & Sell Strike minus the Net Premium received. It’s always better to get this economics right before entering the trade.

Trading Technique #2

As far as individual stocks are concerned, we can resort to options there as well. However, we need to keep in mind that there will be a lack of big moves, so adjust the trades accordingly. Also, care must be taken for the fact that stocks and indices could keep moving down from the upper end of the range and moving up from the lower end.

To handle this:

1. While trading stock options, we could keep our price target and stop losses smaller.

2. Take trades in single Options (Buy Call/Put) for 1 -2 days

3. When we are close to a recent high, have a mix of Buy Call & Buy Put (Bullish & Bearish) trades

Range-bound market has an attractive characteristic of not having to commit to the trade for a longer period. History says that many small trades do improve the probability of profit. So, range-bound markets are also equally profitable if traded effectively using Options.