❝Hedging will fetch bet­ter re­turns in cur­rent un­cer­tain global en­vi­ron­ment❞

Ms. Sneha Seth Deriva­tives An­a­lyst An­gel Broking

Dalal Street Investment Journal - - SPECIAL REPORT -

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.

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