Violent moves do tend to push the premiums higher but it is always prudent to keep away from shorting Options in the direction of volatility.
There have been a lot of discussions about how to optimally monetise the potential opportunities using Options. Well, with the market on a spur, let us take a moment to discuss how one can withhold these gains.
One of the best ways to withhold these gains is by using Options in the unfavourable direction.
Similarly, for every fresh trade after a big move up, one may find a need to be prudent. Once again, here is an additional leg of option monetising, the unfavorable direction would be a good idea.
For example, X stock is trading at Rs 100. We buy the stock in course of time it moves up to Rs 110, now to lock the profits a 110 Put can be bought.
Buy a Put option would hedge any unfavourable outcome from that price point. If the price starts moving lower or below Rs 110, then the Put option would at least partially compensate for losses on the original position.
Similarly, if one were to create a position in X stock at the price point of 110. The strategy would be to go for a Long position in 110 Put alongside a Long in underlying via Futures or Cash equity.
These situations are quite common in moves, post important breakouts. As one can see, while in the first case the Long Put alongside locks the profit already made, the second one makes a prudent attempt at locking any additional losses over and above the sunk cost of the long Put.
Executing this is very simple as the second case would be the initial step in a rising market. While one assumes the sunk cost and holds on to the position through the thick and thin over the course of the expiry, there is scope for one improvisation.
The improvisation is simple, in case the stock starts moving in a favourable direction, bring the Put strike up, thereby once again locking the gain up to the Put strike.
It's a lossmaking exercise on the Put but using Put options put us in an overall gaining state.
Carrying forward with the same example if after initiation at 110 along with 110 Put long at 2 does actually materialises and the stock moves up to 113, wise step would be to square off the 110 Put at whatever price it is and create a fresh long position in 113 Put (provided the strike exists) at 2.
Finally, one caveat is the violent moves do tend to push the premiums higher but it is always prudent to keep away from shorting Options in the direction of volatility.
Meaning, I would refrain from selling 115 Call at 110. As this exercise would not limit my profits instead of locking them.
The same theory holds good when we are falling apart and a short position is created and a Long Call is kept to lock the losses and lock the profits.
The author is CEO & Head of Research at Quantsapp Private Limited.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.