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Optionalysis: Portfolio Trades In a Trending Market

Deepak Shenoy5 min read
Quick Facts
What is "Optionalysis: Portfolio Trades In a Trending Market" about?
What category is this article in?
Premium
Who wrote this article?
Deepak Shenoy, Capitalmind's research team.
When was this article published?
Published 4 February 2014.
How long does this article take to read?
5 min read
What topics does this article cover?
Options
What does the "ICICI Bank Falls Through" section say?
ICICI Bank seems to have broken through a near term support at 1,000 recently and looks bearish. At Rs. 970, it’s weak at multiple levels - sitting through a trend down-channel and a head and shoulder formation at the top that looks strangely similar to how things were in May/June 2013 (watch the downtrend then) You can see the recent lower highs and lower lows, and today’s low is just a continuation.
What does the "Petronet: A Long Sudden Trend Play" section say?
The move in Petronet (and Indraprastha Gas) have been sharp, with a 3% bounce. The stock looks poised for an upside touch of the 120 level, if it were to cross Rs. 116.
What does the "The DLF Downmove" section say?
A third entry is in DLF, which is again showing signs of moving back down to its recent lows. We would trade this by writing calls at a strike of Rs. 145, if the stock shows a break down (MACD crossover on the hourlies is awaited).
What does the "Intimidated by the Technicals?" section say?
An aside: If these charts and lines and terms like MACD flummox you, don't despair. Capital Mind Premium is starting a series of posts on the concepts of technicals, how they are applied and why they are a useful thing to look at along with the fundamentals. This will come to your mailbox once a week starting in Feb 2014.
What does the "So Many Trades!" section say?
The point of this trading strategy is to diversify among different stocks, because all bets are based on short-term technical analysis and could easily go wrong very fast. To give us real returns we must bet on different stocks, and potentially in different directions. And choose short options, long options or spreads.

This is an archived post for Capital Mind Premium subscribers, sent on Feb 03, 2014. Click here to know more!

In today’s Option Strategy we’ll run through a trading plan for the next day. While the market has moved in a strong downtrend today, a number of stocks are demonstrating the kind of weakness we might be able to cash in on through options.

This will introduce us to a diversified option strategy instead of a single stock or index focus. Right now, remember that option premiums are very low with a volatility expectation that is just 18%, and going short options involves considerable risk, both through adverse reversals of the trend, or through an increase in time value due to an increase in volatility expectations.

ICICI Bank Falls Through

ICICI Bank seems to have broken through a near term support at 1,000 recently and looks bearish. At Rs. 970, it’s weak at multiple levels - sitting through a trend down-channel and a head and shoulder formation at the top that looks strangely similar to how things were in May/June 2013 (watch the downtrend then) You can see the recent lower highs and lower lows, and today’s low is just a continuation.

The downside support is the “Rajan Gap” which is what took banks up on September 5, a gap we haven’t seen covered since. In the near term, looking at the hourlies, there are signs of another breakdown.

We have a potential MACD down-cross soon on the hourlies, and RSI isn’t telling us this is oversold. We could quite easily see the stock breakdown further.

Tomorrow if the stock stays below Rs. 970, either of two trades will be added to the portfolio:

  • Buying a put at Rs. 980 strike or whereabouts. Essentially an at-the-money option.

  • Selling a call at Rs. 1040 or 1060 level, where the premium is Rs. 12 to Rs. 9.

In both cases, we will be carrying** two contracts** and keep a stop loss on the future at the 1020 level where the downtrend channel would be broken. This trade will take an allocation of Rs. 2 lakh (Note: buying two puts will only cost us Rs. 20,000 and writing two calls have a margin of only about Rs. 75,000. We allocate more to reduce leverage.)

Petronet: A Long Sudden Trend Play

The move in Petronet (and Indraprastha Gas) have been sharp, with a 3% bounce. The stock looks poised for an upside touch of the 120 level, if it were to cross Rs. 116.

When you expect a smart sudden move the best trade is to go long options. The 120 call trades at Rs. 2.2. If the stock continues to stay above the 20 DMA our bet would be** the 120 call (long).**With a lot size of 2,000, we would take three contracts given the overall portfolio exposure of around Rs. 5,000 loss per trade. (assuming we get out with a 50% loss).

The DLF Downmove

A third entry is in DLF, which is again showing signs of moving back down to its recent lows. We would trade this by writing calls at a strike of Rs. 145, if the stock shows a break down (MACD crossover on the hourlies is awaited).

An aggressive trade would be to short two contracts (lot size: 2000). Margins are only Rs. 40,000 per contract. Given where prices are, we could consider a bear call spread (writing the 145 call and buying the 150 call) to cover for rebound risk.

Intimidated by the Technicals?

An aside: If these charts and lines and terms like MACD flummox you, don’t despair. Capital Mind Premium is starting a series of posts on the concepts of technicals, how they are applied and why they are a useful thing to look at along with the fundamentals. This will come to your mailbox once a week starting in Feb 2014.

In option trading it would be a disaster to trade purely on company news, in India at least; options decay very fast, only near month options are liquid, and you have to have serious insider knowledge. (Also read how I learnt this the hard way: I am a stupid investor)

So Many Trades!

The point of this trading strategy is to diversify among different stocks, because all bets are based on short-term technical analysis and could easily go wrong very fast. To give us real returns we must bet on different stocks, and potentially in different directions. And choose short options, long options or spreads.

Remember three things make up a good trade:

  • A proper entry. The stuff described above may be unwise to trade in options if the prices are way off! Futures might turn out to be a better position.

  • Proper Money Management. Just because those Petronet options are Rs. 2.2 each, doesn’t mean that we buy 50,000 options and assume allocations of Rs. 1 lakh. The essence of a trade isn’t what you allocate, but what you are willing to lose.

  • Exit strategy: You should have a knowledge of what you will do if the position turns into a loss (stop-losses, offets with other options, buying a future). We have in the recent past converted a short call into a short strangle, and benefited from the time decay even though the position turned against us.

At any point, an overenthusiasm to trade even on unlikely rewards, a feeling of taking revenge on a stock, or a sense of extreme despair are points where you should stop trading completely. I will elaborate on these in future posts.

We’ll update the portfolio tomorrow. As always, remember that these posts are education only, not advice. While we have real money behind the trades we take, we would not expect anyone to follow us blindly. Do your research and understand the risks before you trade!

Tagged:Options