Here's how to trade market pullbacks efficiently with step execution

F&O Market

A pullback is popularly used to characterise a move that is opposite to the ongoing trend. In an uptrend, we normally hear the investing community say that “pullbacks” or “corrections” are an opportunity for bargain- hunting.

But, for us traders, pullbacks disturb the short-term trading system, as stocks start to move down back-to-back while we have been placing bullish bets. We do realise that the pullback may be temporary but as traders, we do not want to miss out on a directional opportunity either.

Step execution has worked for me during pullbacks. It is a good approach for temporary moves. Step execution helps in getting the commitment level to the trade go up only if it turns profitable. Let us understand.

This approach makes it clear that after a big move, there can be a bit of nervousness in the market. The nervousness triggers a drop. Every market condition has its sets of winners and losers. Simply set your eyes on an expected underperformer.

Step 1

Usually, we would not want to create a big sell position in a pullback even in an underperformer but a smaller trade would not hurt.

So, start small by buying a relatively lower strike Put option with a view to hold it till the price indicates underperformance. In other words, intraday stop-loss in the stock not in the Option.

Once done, all we can do is monitor. Any one out of the three mentioned scenarios can play out during the day. The next move will depend on what happens.

Step 2

In case the view materialises during the day, on intraday fall, go ahead and sell 2 step lower strike Put option than the one we bought. This will create an unbelievably lower-cost Option Strategy. Here the profit would be the difference between the Buy Strike and the Sell Strike. But, more importantly, we would have done a kind of profit-locking.

The Put option bought before the fall and the lower strike Put sold after the fall would be executed at almost the same price. In such a situation, the maximum loss in this trade is almost zero (cost of buying-selling options).

This position may or may not make money but it will not create a loss. We can hold on to it for a longer period of time as insurance against any bargain-hunting Buy position taken during such pullbacks.

On the other hand, if the move is unfavourable, remember our position is in a lower Put option with a stop loss in underlying. If that level does not hold, sell the option as the main uptrend may have resumed.

Lastly, if nothing happens and the stock is around the same level the whole day, do a time stop-loss and close the option.

Remember, we are trading a temporary move, so commit Step 2 only if you see gains in the initial option.

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