Traders who habitually sell out-of-the-money put options to collect small premium got a reminder last week that what appears easy money in the derivatives market comes with risks that can take away months of trading gains in a few days.

Thursday saw twin expiry, of weekly banking Nifty options and Nifty derivatives contracts. It was clear that traders with short positions were in no mood to cover their positions. Rather, traders with long positions were grappling with a dilemma whether or not to rollover their positions. Like selling of put had become an easy trade, if the Nifty corrects a bit more, selling out-of-the-money call options would also appear an easy trade. But one should resist the temptation to sell call options, because recoveries in the bull market tend to be very sharp.

As far as Nifty trade is concerned, whenever expiry day sees extreme sentiment, it would be better to wait for the new series to settle before doing a trade of current month series. The first three to four trading sessions of any series are governed more by confidence than reason.

For example, at the expiry of the August series contracts, bears were caught on the wrong foot and bulls dominated for the next few sessions. Now, in the September series, bears seem to be dominating. So the initial days of the October series could give an impression that it is bears all the way. So, wait for a few more sessions to see if the Nifty makes a bounce back, if it doesn’t, surely there are higher chances that we might see another round of correction.

Put options pricing for the October series shows some extreme out-of-the-money put options are more expensive than near-the money options from the October series. Also, last Thursday, the way open interest had got built gave an impression that everyone wants to either hedge or speculate. If the Nifty does not see a short covering bounce, traders should look for intraday opportunity to short Nifty futures and hedge positions by buying at-the-money call options from the October series. This trade will give money only if the decline in Nifty futures is more than the money spent on buying call options. This trade can also lead to a loss if the Nifty does not fall and the time value of call options declines. But remember that no situation offers a perfect hedge in equity markets.

Professional traders may look at selling multiple straddles. But this should be done with stop loss in place on the combined value or, because the market is in corrective mode, put options should be bought to cover the lower end of the trade.

rajivnagpal@mydigitalfc.com