All the investors in the stock market are the fearful of the last day of February. This is the day when the budget for India is presented. And depending on the statements of the finance minister the market moves in a big way -- either up or down, that is, the market will be very volatile.
If there was a way you could know what the finance minister will say just about 15 minutes before he would say it you would become a very rich person. But that's just wishful thinking.
However, one thing that every investor knows is that during the budget the markets will either move up very strongly or vice versa. But can we use this information to make money? Yes! We can and we can handsomely profit from this.
There is a strategy that can be used in the futures & options market that can give you limited risk and very high return. The good thing is that we don't even have to guess which side the market will go. In simple words:
~ If the market goes up -- you profit.
~ If the market goes down -- you profit.
~ However, if the market stays where it is (Chances of which during the budget day is nearly zero) -- you lose.
Here's how you can win
There is something called as the 'Straddle strategy' in the futures & options market.
The Straddle strategy is an options strategy that's based on buying both a Call (a right but not an obligation to buy a stock at certain price on a predetermined day and price) and Put (a right but not an obligation to sell a stock on a predetermined day and price) of a stock.
To initiate a Straddle, you could buy a Call and Put of a stock/index with the same expiry date (the last Thursday of every month) and strike price. This is the price at which a specific derivative contract can be bought (in case of a Call) or sold (in case of a Put) irrespective of what the price is on the date of expiry.
Strike prices are mostly used to describe stock and index options, in which strike prices are fixed in the contract. For Call options, the strike price is where the security can be bought (up to the expiry date), while for Put options the strike price is the price at which shares can be sold.
For example, you could initiate a Straddle for Nifty by buying a March 5,200 Call as well as a March 5,200 Put (here expiry date is the last Thursday of any given month and the strike price is same, that is, 5,200). The minimum shares you can trade in the Nifty are 20 and 50.
Let's assume you choose a 50-share contract. The Call option for 5,200 costs you Rs 150 and the put option for 5,200 costs you 120 (when people expect markets to go up the Call option premium is more than the Put option premium and vice versa). Therefore your total investment would be Rs 13,500. This is how it is calculated:
The total amount you spend in buying both the Call and Put options = Rs 150 + Rs 120 = Rs 270.
Total contract size = 50 shares * Rs 270 = Rs 13,500.
Why buy both a Call and a Put?
Remember that for this Straddle strategy to make money for you the value of Nifty should be either above (Rs 5,200 + Rs 270) or below (Rs 5,200 Rs 270). This is because you have paid a premium of Rs 270 per unit of your contract size of 50 shares.
Call option will help make you profit if the Nifty goes above (Rs 5,200 + Rs 270) levels.
Suppose that after the budget day (you have almost 30 days after the current expiry day (February 28) , that is, the last Thursday in March) the Niifty touches Rs 5,900. Then you stand to gain Rs 700 minus the premium you have paid, that is Rs 270 per share of the contract.
In this case your profit will be (Rs 700 - Rs 270) * 50 = Rs 430 * 50 = Rs 21,500.
Similarly, the Put option will help you make money if the Nifty goes (Rs 5,200 Rs 270) levels.
Suppose that after the budget day (but before the last Thursday in the month of March) the Niifty touches Rs 4,500 levels.
In this case your profit will be (Rs 700 Rs 270) * 50 = Rs 21,500.
So, in either of the two scenarios -- the market moving up or down -- you end up making profits. However, as mentioned earlier you must remember that this is not a foolproof strategy.
You can also end up making a loss on your Call option if the Nifty does not go above (Rs 5,200 + Rs 270) or falls below Rs (Rs 5,200 Rs 270) levels.
In both the scenarios the maximum you can earn is Rs 21,500 and the maximum you can lose is Rs 13, 500, that is, the premium you have paid.
In an ideal world, you would like to be able to clearly predict the direction of a stock/Iindex. However, in the real world, it's quite difficult. On the other hand, it's relatively easier to predict whether a stock is going to move (without knowing whether the move is up or down).
For example, it's like you think that the FM could announce a package for dollar hit companies in the information technology or the textiles sector, in his budget speech, but do not know whether they will exceed expectations or not.
You could also assume that the stock price of Infosys will be quite volatile, but since you don't know the kind of package that could be announced in the budget for the IT sector, you wouldn't have a clue which direction the stock will move.
In cases like this, a Straddle strategy would be good to adopt.
If the price of the stock shoots up by more than the premium you paid, your Call will be way in the money (profitable), and your Put will be worthless.
If the price plummets by a value that is more than the premium you paid, your Put will be way in the money (profitable), and your Call will be worthless.
This is safer than buying either just a Call or just a Put. If you just bought a one-sided option, and the price goes the wrong way, you're looking at possibly losing your entire premium investment.
If you had just bought a Call option for Infosys for the strike price of Rs 1,560 for a premium of Rs 35 per share and a minimum contract of 100 shares and the FM does not announce the package then the Rs 3,500 (100 shares * Rs 35 premium) investment would be nearly zero in value.
In the case of Straddles, you will be safe either way. However, you are spending more initially since you have to pay the premiums for both the Call and the Put.
If Straddles are so good, why doesn't everybody use them for every investment?
~ It fails when the stock price doesn't move or if the price of the stock hovers around the initial price. In both the cases the Call and the Put will not be that much in the money.
~ The closer you come to the expiry date, the cheaper premiums are because option premiums have a 'time value' associated with them. So an option expiring this month will have a cheaper premium than an option with the same strike price expiring next month.
~ So in the case where the stock price doesn't move, the premiums of both the Call and Put will slowly decay, and you could end up losing a large percentage of your investment.
~ The bottom line, however, is: for a Straddle strategy to be profitable there has to be volatility and a marked movement in the stock price. And right now and during the budget India is likely to be a hot spot of volatility.
Rediff disclaimer
This article is for illustrative purposes only. Readers should take the help of professional financial advisors before investing their money.
