Learn how to profit from an oscillating market strategy

Shubham AgarwalQuantsapp Private 

A trending market always attracts the attention of all traders. But there is another dimension which is not discussed that often and which is an oscillating market. Today, we will talk about the most basic strategy that works especially well in an oscillating market set-up.

In simple words, oscillating market is defined as a market which reverses its gains after a big move and then rallies back again, or a market which moves repeatedly back-and-forth.

But before we do that, let us first understand an important Option internal, Delta. Delta is nothing but rate of change in an Option with respect to change in its underlying price.

If looked at the same internal from a different angle, Delta is a fraction of total exposure of the underlying.

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CEO and Head of Research|Quantsapp Private Limited

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Let us understand this concept better with the help of an example. Suppose, stock X is trading at Rs 1,000 and has 1,000 CE trading at Rs 30. If the stock rises to Rs 1,010, the Call will also rise. Considering the Call goes up to Rs 35.5, we can conclude that the Delta of 1,000 strike call is 50.

A Delta of 50 indicates there would be a 50 percent movement in the underlying stock. Considering with the underlying at Rs 1,000, the Call is capable of returning 50 percent of the stock as denoted by its Delta. We can also say that 1,000 Call represent 50 percent of the stock, with the counter trading at Rs 1,000.

One more very important characteristic of Delta is that it is an increasing function of price for a Call Option and decreasing function of price for a Put Option. Let us understand it further.

Increasing/decreasing function means that as the price increases Delta for a Call would increase. Taking the previous example forward, at Rs 1,010 Delta of 1,000 strike Call would be higher.

If the stock goes up from Rs 1,010 to Rs 1,020, the 1,000 Call would be Rs 41. This means that there is an increment of Rs 6 this time against the next Rs 10 move in the underlying.

The sensitivity increases, in other words the Delta increases to 60 percent now for the Call as the stock goes up. The speed at which this Delta increases is also of importance but is a separate topic in itself.

Similarly, if we had a 1,000 strike Put and it moves from Rs 990 to Rs 980, here too with every incremental negative move the Delta will increase.

Basically, 1,000 Put would represent a Delta of -50 percent. The same Delta would go to -60 percent as we move to Rs 990, increasing the premium growth on the way to Rs 980.

This Delta figure would be available to you on any standard Option calculator easily and freely available on the web.

The actionable out of this entire explanation is simple. Buy the Option and take an offsetting position to neutralise the Delta. In an attempt to do that, one would create a trade set-up that is beneficial.

Meaning, buy a 1,000 Call, having 50 Delta. Create an offset by selling 50 percent quantity of the lot size. And now keep managing the offset.

If the stock goes up and Delta goes to 60, sell an additional 10 percent. If the stock goes down to Rs 990 and Delta goes to 40, buy back 20 percent.

Considering that the calculations and intervals of this offsetting exercise is not continuous and are periodic, the buy low and sell high would end up outperforming the premium paid to acquire the Option.

A similar trade could be done in Puts as well. For all practical purpose, these trades come in very handy when the markets loiter around at lower levels. One is waiting for stability to buy. This is an ideal deployment.

It is always profitable to know this kind of market neutral strategies as well, as one is capable of trading other than just unidirectional moves.

The author is CEO and Head of Research at Quantsapp Private 

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.