❝Hedging will fetch better returns in current uncertain global environment❞
Ms. Sneha Seth Derivatives Analyst Angel Broking
It doesn’t matter whether the market is bearish or bullish, derivatives work anyway. Does the statement hold true according to you?
Yes, one of the best advantages of derivatives segment is that it can be used in both bullish as well as bearish market, unlike the cash segment. Traders can only buy stock and hold the same in case of cash market segment, though only intra-day traders have the privilege to form shorts without holding the underlying stock in their demat accounts. With emergence of derivatives platform, traders can short sell and hold on positional basis to take advantage of a bear market condition.
How do we bifurcate strategies according to market conditions? Which is the best strategy you suggest in the current market situation?
There are various strategies for all kinds of markets, whether bullish, bearish, sideways and volatile. In case the overall market is trending northwards and the trader is very bullish, one can simply buy futures or naked call options of the stock; while if the trader is bullish upto certain levels or is mildly bullish, he can adopt bull call spread which will help to keep himself hedged in adverse situation and will lower the cost incurred. Simultaneously, buying At-the-money (ATM) and writing Out-the-money (OTM) call option is known as ‘Bull Call Spread’. Here, loss is limited to the net premium paid and potential profit is restricted to a difference between both
strikes minus the net premium paid.
Similarly, in a bearish market scenario, if one is bearish, he/ she can opt to short futures or buy naked put options. In case the view is slightly bearish, trader can build bear put spread by buying ATM and writing OTM put option.
Historically, it has been observed that most of the times market likes to remain in a relatively narrow range and most of the traders eventually end up making huge losses due to aggressive positions and, importantly, due to lack of knowledge on how to tackle such market conditions.
But with the help of strategies like short straddle and short strangle, traders can overcome losses incurred in the above market conditions. Short straddle is done by selling both call and put option of same strike price and if index/stock expires near the strike price we sold, one can pocket in the entire premium received. But if market heads one side due to any reason, the same strategy may lead to losses. The only difference in strangle is the strike price as it is carried out by using out-the-money strikes of both call and put options. This strangle has the ability to save both money and time for traders operating on a tight budget.
Some events like monetary policy announcement or quarterly results outcome or any global geopolitical news may lead to enhanced volatility. By using options, one can even make money, irrespective of market moving in either direction. Long straddle and long strangle strategies can be used if one expects market to remain volatile in the near term. Here, the only difference is that instead of selling, we buy both call and put options. Maximum loss is limited to the premium paid; while profit depends on the market volatility. Apart from the short term traders, options can also be used by the long term investors to earn some return on money invested or by investors who want to lower the cost of their existing portfolios, by opting for covered call writing. In this case, one can write OTM call option of the stocks you hold, which may give some
additional return on investment.
In calendar year 2017, equity market has given fantastic return so far and the major trend remains bullish going ahead. However, taking into consideration the FIIS outflow last month and the overall F&O activity, we expect market to remain under pressure in the near term. At the current juncture, a strong hurdle for Nifty is seen around 10000-10100. Thus, would suggest long term traders to remained hedged; while short term traders can short index futures with long index call options.
Would you suggest derivatives trading to a stock market entrant? What instrument would you suggest him/her to begin with?
Honestly speaking, we would never suggest any newbie to start trading, especially in derivatives segment. New entrants should take tiny steps by first stepping into equities and later with better understanding of the market and the derivatives product, one can start small trades in F&O segment.
According to you, which technique (arbitrage/hedging) would give better return in this volatile markets?
We believe the key deliberation behind the derivative instrument is hedging. Hedging is very similar to an insurance product that we commonly buy for protection against a possible eventuality. Every individual trading in stock market is also exposed to a certain risk. In the event of any adverse market movements, hedging simply protects your trading positions from incurring heavy losses. Thus, hedging one’s positions will surely fetch better returns in current uncertain global environment.
What percentage of savings should be utilised for derivatives trading? Is there any ideal margin percentage a trader should take from a broker?
Trading in derivatives segment primarily depends on the risk appetite of the client. So, traders with high risk appetite should only prefer trading in F&O segment.
Despite complexity, turnover in derivatives was 15 times that of cash segment in FY17. Could you please throw a light on traders’ psychology here?
Nowadays, many traders prefer trading for shorter time horizon like intra-day, 3-7 days or 1-2 months. In such cases, traders are more keen to earn returns at regular intervals with small investment rather than blocking big corpus to take same exposure in the cash market. As we all know, derivatives are highly leveraged product, especially options are very attractive for small pocket traders.
SEBI is said to be mulling over rules for derivatives trading considering its risky nature for individuals. How would it impact your business?
Yes, SEBI has been consistently tweaking the regimes in F&O segment, like changing the futures contract size to 5 lakh last year and the most recent addition of ‘Do Not Exercise’ feature to options contract in order to help retail participants.
There would always be some or the other pros and cons that we come across with revolutionisation coming in. For that matter, increase in the lot size of the F&O contracts has certainly forced traders who religiously want to trade to shift to higher contract value as they have no option left, which may also come with the higher risk factor attached to bigger contract size. At the same time, adding the ‘Do Not Exercise’ feature in options segment has been a relief for the buyers of options who faced imposition of STT of 0.125% if they left an ITM option to expiry. Moreover, the STT in this case were calculated on the notional value of the option and not on the option value which can actually be devastating. However, these changes hardly have any notable impact on the business as traders who want to trade will trade, irrespective of any changes made from the regulatory bodies.