Chartist Talks: Use hedging strategies instead of naked options positions ahead of poll results — Sudeep Shah, SBI Securities

Sudeep Shah, Deputy Vice-President and Head of the Technical and Derivative Research desk at SBI Securities

As the market approaches the outcome of the Lok Sabha elections, Sudeep Shah of SBI Securities strongly recommends using hedging strategies. "Options traders, in particular, should avoid naked (unhedged) positions whenever possible," he said.

He also suggests that market participants stay away from over-leveraged trades.

Regarding the sectors to focus on, "considering the rollover data and current chart structure, the automobile, capital goods, and pharma sectors are likely to outperform in the next couple of trading sessions, while IT stocks are expected to underperform in the short term," said the Deputy Vice-President and Head of the Technical and Derivative Research desk at SBI Securities, who has more than 15 years of experience under his belt.

What insights are the Nifty charts providing ahead of the results?

Since the beginning of calendar year 2024, Nifty, a benchmark index,  has been oscillating in a rising channel pattern. In the current week, the index has tested the upper trendline of the channel, and thereafter witnessed a sharp correction of nearly 3 percent. This resulted in the formation of a Dark Cloud Cover candlestick pattern on the weekly scale, which is a bearish sign.

Along with this bearish formation, the index has slipped below its short-term moving averages, i.e., the 13 and 20-day EMA levels. Further, the daily and weekly Relative Strength Index (RSI) has seen a bearish crossover, and it is falling. Interestingly, on the weekly scale, the price has hit four higher highs in recent times, but most of the indicators, including the RSI, have not reached near the prior highs. The Commodity Channel Index (CCI) has also shown the same. This clearly indicates that the upside momentum is waning.

Going ahead, the 22,330-22,300 zone will act as immediate support for the index as it is 61.8 percent of the Fibonacci retracement level of its prior upward move (from 21,821, to 23,110). If the index slips below 22,300, then the next support is placed in the  22,030-22,000 level as it is the confluence of the 100-day EMA and lower trendline of the rising channel.

On the upside, 22,700-22,750 will act as an immediate hurdle for the index. Any sustainable move above  22,750 will lead it to resume its northward journey to 23,100-23,200 levels.

What is your outlook on the Bank Nifty, considering that it has experienced the lowest rollover in recent months?

In the May series, Bank Nifty, the banking benchmark index,  ended on a flat note, with the  lowest rollover since April 2021. The rollover has dipped to 67.66 percent from the previous month's 74.41 percent and the three-month average of 76.43 percent. Moreover, the rollover cost has also decreased to 0.64 percent, compared to the three-month average of 0.73 percent.

The Bank Nifty  formed a High Wave-like candle on the weekly scale, which indicates indecisiveness among market participants. The momentum indicators and oscillators also suggest a lack of strength in either direction. The daily RSI is oscillating sideways  per RSI range shift rules. The trend strength indicator, ADX (Average Directional Index), is quoting below the 16 mark and it is falling.

We believe the  48,000-47,900 zone will act as crucial support for the index as the lower trendline of the rising channel is placed in that region. Any sustainable move below  47,900 will lead to sharp selling pressure in the index. In that case, it is likely to test 47,100, followed by 46,700 in the short term.

On the upside, any sustainable move above  49,500 will lead it to resume its northward journey. In that case, it is likely to test the upper trendline of the rising channel, which is currently placed at 50,500 in the short term.

Why are option premiums currently elevated?

Options premiums are currently quite expensive due to a significant increase in the implied volatility (IV). Major events on the horizon (such as the election results) are driving this spike in the IV, and options sellers are quoting higher premiums to compensate for the same. For example, current at-the-money (ATM) IVs are averaging around 34, compared to their usual range of 12-18.

This heightened volatility poses a challenge for traders, as a sudden IV decline following the poll results could lead to a drastic reduction in options prices.

How should traders approach the results?

As we approach the final days before the event, it's crucial to resist the temptation to engage in over-leveraged trades. Implementing hedging strategies is highly recommended. Options traders, in particular, should avoid naked options positions whenever possible. Naked options buyers risk significant premium erosion due to theta decay, while naked options sellers face the potential of unlimited losses if the market moves against them.

Which sectors are expected to remain in the limelight?

Considering the rollover data and current chart structure, the automobile, capital goods, and pharma sectors are likely to outperform in the next couple of trading sessions, while IT stocks are likely to underperform in the short term.

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