Stock Market Volatility: 5 F&O Strategies That Can Help Traders Make The Most Of Volatility

The rise and fall are an integral part of investing in the stock market.

Each phase of the market is unique and requires the right approach, with the right mindset, to limit losses or maximize profits, as the case may be.

Most of the time, investors fall under wishful thinking and try a long period of correction and stagnation, leading to negative portfolio values. Contrary to investor expectations, earnings are never linear and are mostly irregular.

Most stock investors participate only on the buy side and do not have a plan to protect the portfolio against potential changes in the market, resulting in below-average performance.

An investor should remember and do some basic research as a large part of stock price movement occurs in just a few trading sessions. The solution to this is to be a patient investor, as stocks always rise over the long term, as long as the funds are deployed in quality stocks with solid fundamentals.

Here are some useful techniques to help you navigate through the volatile phases of the market.

1. Protect the wallet
Coverage is an important part of any bumpy ride on the market. A portfolio can be hedged by buying Nifty Put or Bear Put Spread, ie using monthly contracts or long term options, after understanding the composition of the portfolio.

The hedging exercise would depend on the type of stock in the portfolio and its beta. For example, in a portfolio with a large-cap Nifty name, it’s easy to get to beta and plan your hedging strategy compared to small- and mid-cap names.

For a portfolio with mid-cap names, you need to decide on the right instrument to hedge (Nifty or stocks), the right strike and amount for the spread, and lastly, position tracking and exit.

It should be noted that hedging or mitigating risk does not happen without incurring additional costs and different underlyings have different betas. Often times, perfect hedging may not occur, but partial hedging also helps safeguard the existing position.

2. Create short positions in stock futures
In a bear market, selling futures provides an opportunity, as many weak stocks fall sharply. It is always advisable to be with the trend until it doubles. In a weak market trend, trading short should be more than taking a long position.

a. Based on a top-down approach, one can discover weak sectors and stocks to initiate short selling ideas to generate alpha in the market. Stock-specific bearish call and put options can also help take advantage of the opportunity during a corrective market phase.

B. To select stocks, T is ideal for choosing a stock that has a weak structure. A moving average with crossover and trend line breakdown are some of the technical indicators to identify short stocks. Another derived indicator for identifying short stocks can be based on open interest (OI) aggregation (short build and long draw), higher call option writing, and stocks with a lower call ratio.

3. Generate profitability through call writing
Call writing is the best and most well known method that reduces the cost of holding positions and generates additional return on an existing position.

a. For this, investors must decide on stocks to write Option/Put based on the stock’s specific liquidity and maintain a safety margin while writing strikes. The exercise price can be based on the cushion and the performance of the sufficient premium. Traders need to monitor the position by placing certain alerts in the system that will help decide the exit or follow mechanism.

B. The call write only generates an input stream as a bonus, but any larger increase in actions beyond the write strike may not help generate any real desirable performance. It is more suitable for participants looking for consistent cost reduction and a certain percentage of profit scenarios.

4. Long and short trades
Pairs trading provides an added advantage in such market scenarios as many pairs such as HDFC Bank and HDFC are highly correlated and provide opportunities when they deviate from their mean. The risk is comparatively low in pairs trading as both stocks have long and short exposure to the market.

5. Trade on options strategy and option spreads
When market sentiment is bearish, volatility generally remains high and so does the option premium along with increased market risk.

Writing options in higher implied volatility (IV) scenarios is not recommended, even if the option premium is high. It is better to go with the Butterfly and Iron Condor strategies rather than just Sell Out of the Money (OTM) Calls and Puts.

The sale or purchase of a futures contract should also be hedged with protective put and call options to mitigate risk. This exercise will help avoid panic over margin calls.

Traders are advised to liquidate most intraday naked positions and avoid carrying much leverage until India VIX (volatility) drops back into comfort zones.

Fundamental analysis is the guide to long-term investing. Likewise, technical analysis is the winning tool for traders to make a profit in this ever-evolving market.

(Chandan Taparia is vice president of technical research at Motilal Oswal Financial Services. Opinions expressed are personal.)

Previous post Economic conditions could deteriorate, but right now they don’t warrant another check
Next post The US economy is not letting war and the pandemic stand in the way of a good time
%d bloggers like this: