The market has been in a tailspin for over a week, barring some recovery on October 27. Whenever such a fall comes, one wonders if it is an opportunity for bargain hunting.
Many times, the fall is overdone and then a pullback, if not a full reversal, follows, making a quick buck for the strong-hearted traders. But there is a risk to it as well.
The fall could continue, exposing the quick, small-profit-seeking trade to the risk of a big loss. But with options, a limited loss strategy is possible even in times of a big unfavourable move.
Synthetic Call Buy
The strategy is created by a simple combination of future and put option. We buy the future and the put option simultaneously of the strike close to the current market price.
Why Synthetic?
This is because expiry day profit or loss incurred by buying future and buying a put option is the same as buying a call option. Why do we follow this strategy instead of just buying a call option?
Well, there are small advantages, more qualitative than quantitative. Let us see them one by one.
Remember along with the future we have bought the put option. Assume that the market goes down further and extends the fall in the current move. What would be more in demand the call option or the put option?
Higher demand will make the price of the put option rise at a faster pace than during normal times. The fall-related increment in the put option along with demand-related extra rise makes the put option better placed than a call option in case of a further fall.
During the fall the Future contract would be bleeding (incurring heavy loss), so every little extra bit of offsetting profits from the Put Option will help.
Risk management
Risk management becomes very easy when it is a synthetic future. A simple call option can be managed with a stop loss and revision of the same during the tenure of the trade, however, with the synthetic call we can do more.
Imagine a tiny up move comes in, turning the position into profits but you expect the move to last longer. Here, because the buy future is your primary position, you can simply book a tiny loss (compared to a profit in the future) in the put option and buy one step higher strike put option.
This may not raise the profitability of the trade but in case this turns out to be a temporary move and we come back down to where we started from, the position might have some profit left for us to earn.
This can be done in buy call trade by switching to a higher strike call option as well. But behaviourally, one would not want to book profit in a bigger money-maker call option and buy a smaller money-maker call option. Higher strike call options rise less for every rupee rise in the stock.
Thus, it makes sense to bargain hunt with Synthetic Call Buy. Lastly, just like all bargain-hunting trades, it is advisable to hold this trade with a time-bound two or three sessions.
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