This year can be termed as a year of more events than ever. We are not completely done with digesting the mega event of union elections. Now we have another round of excitement sourced from the upcoming budget in a few days and, of course, the quarterly numbers. What this excitement is translating into is the change in implied volatility resulting in changes in premium without change in price.
So, we will revisit some of the tips and tricks that can come in handy as far as the investments and trading is concerned. While the Investment bit would be more beneficial to enchasing the excitements in individual stocks, the trading piece would be universally applicable.
Investors or Medium-Term Traders Optimize Pay-Off in following ways:
1. With the event-led volatility in expectation, there would definitely come a fear of losing wealth if the outcome of the event were to be worse. Here, we can buy a Put of a strike below which one would not be comfortable holding the stock. In case the stock falls below the strike after the event, upon Expiry, we have a choice to sell the stock at strike price.
2. Post the event, there could be volatility pushing prices to mouth-watering levels, but there is always a risk of losing while trying to catch a falling knife. Buy a Call instead, now one gets choice to buy the stock on the day of expiry. Exercise the choice if the stock ends up above the Strike Price upon expiry. But, in case the stock were to fall further, just do not buy it.
In terms of transaction cost, Cost would be Premium (3-5 percent of the Stock Price). Put Option will protect the investor against any fall below the strike price at the end of expiry. Call Option Premium is paid to buy a comfort of getting in only if turns out to be a money maker.
For Traders, there would be slight modification in the approach. The implied volatility would be on a rising spree to account more and more for the event as the event keeps coming closer.
Following Alterations in the selection to Option Strategies could help perform better with the event in front:
1. Incremental deployment of Single Options: For directional trades Shorten the horizon as much as one can and increase the share of time bound Single Option Trades so that any inorganic rise in premium boots the profits.
2. Restrict Ratios to Expiry Week: Execute Ratio trades when one Buys one Call/Put and Sells multiple Higher Calls/ Lower Puts only in the week when the said contract is about to expire. Such Trades could turn dangerous when Implied Volatility is rising, hence execute ratios when the impact of Implied Volatility does not bother the trade i.e. in the final days of expiry.
3. Introduce Back Ratios: Finally, in normal times, this may not be a preferred strategy on the list, but it is apt when the implied volatility is in a rising mode. Back Ratios are executed with via Selling a Call/Put close to CMP, and Buying Multiple higher strike Calls/ lower strike Puts.
This strategy helps gaining out of direction as well as implied volatility, but the drawback is that it is heavily negative on Time Value. Hence, only deploy in the first three weeks of the expiry that too with reducing time stop loss of 5, 4 & 3 Sessions as the expiry gets closer.
These modifications can be used as a guide every time we have an event in front of us.
Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.