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Apr 14, 2018 09:45 AM IST | Source: Moneycontrol.com

Market stuck in a range? Options can still help you generate high returns

"Result season is on the card and Open Interest has a very high congestion around at the money which generally pushes the market into an oscillation and below are two strategies to help you generate returns in an oscillating market," says Shubham Agarwal, CEO & Head of Research at Quantsapp Private Limited.

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By Shubham Agarwal

The market often keeps oscillating in a narrow band which doesn’t leave much opportunity for traders in the Futures market to participate, or even if they trade mean-reversion; minor whipsaws at the bounds are common to eat away stop losses yet doesn’t yield a high return.

Options traders have an edge in trading while the market is oscillating and there are strategies to generate high returns from the instrument going nowhere.

Result season is on the card and Open Interest has a very high congestion around at the money which generally pushes the market into an oscillation and below are two strategies to help you generate returns in an oscillating market.

Short Straddle:

While trading oscillation the agenda from options is to grab the time value which is in our favor. At the money strikes, option premium is all a component of time value.

If the combined premium of Calls and Puts of at the money strikes provides enough cushion of the expected range, this strategy can be beneficial.

For e.g. If the expected range of oscillation in Nifty is 10,300 – 10,700 and the combined premium of Calls and Puts is more than Rs 200 for at the money strike of 10,500, then this strategy is executable as the lower range of break-even is 10300 (Strike sold – Premium received i.e. 10,500 – 10,200) and the upper range is 10,700 (Strike + Premium Received i.e. 10,500 +10, 200).

Short Strangle:

Short strangle is a strategy to gain from oscillation when the expected bounds of the underlying is extreme. The strategy also intends to generate returns from Theta decay of options and the trades are to sell an out of the money call option along-with an out of the money put option.

Let’s continue with our above example. What if the expected range of Nifty is now 10,200 – 10,700? In this case, executing a short straddle doesn’t provide a cushion to cover for the lower bound due to the combined premium of at the money call and put being only Rs 200.

For such scenarios, Short Strangle can be an alternative. A trader can simply sell a Call of 10,700 and a Put of 10,200 to gain from the premiums being worthless on expiry or by premium erosion due to theta decay even during the expiry.

Risks:

While trading both the above strategies we should remember that we are selling options naked and this involves a high risk. Generally, these strategies have a naturally high strike rate as the underlying will mostly be trading within a nearby range but whenever it goes beyond; a strong risk management is the only saviour.

A strict stop loss needs to be maintained for strategy level profit & loss. The two common ways of risk management deployed by ace traders are:

1. Exit if the range is breached – If the expected range was 10,200 – 10,700 and the underlying (in this case Nifty) breaches the bound then the trader can book the loss and exit the position.

2. Exit if the premium doubles – Another way to manage risk is when the premium doubles at anytime. The logic of traders behind this is to maintain a reward to risk scenario. You should not lose more than what you could have earned. So if you received a premium inflow from the strategy of Rs 100 the stop loss of combined premium should be Rs.200 no matter whenever that triggers.

Reward:

Both the strategies will lose time value gradually from the premium which is a profit to the strategy but the best reward would be holding till expiry given the underlying remains within the expected range.

The entire premium received for Short Strange can expire at Zero within the range and for Short straddle profits would be highest if the underlying expires at the sold strike.

Disclaimer: The author is CEO & Head of Research at Quantsapp Private Limited. 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.
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