The recent surge in the Sensex has made a lot of traders come back to the markets. Like the way you have frogs croaking within minutes of a good shower, investors too wade back into the markets the moment you have the Sensex headed north.
And with the benchmark bouncing 24.5 per cent from its lows, the markets have seen a rush of investors wanting to ride the bandwagon. That is where options come in.
While options are always a good way to trade in any markets, it makes more sense today than ever because of several reasons. Whether you want to go long or short, using the options strategy is recommended for the current season.
When you buy an option, be it a call option or a put option, your risk is limited to the premium amount you have paid whereas the upside remains open. So no matter where the stock or the index goes, you can't lose more than the premium paid.
Let's look at some of the reasons why options will make sense.
The Sensex has appreciated 24.5 per cent from its low on July 16 with a high of 15,579 seen on August 12. So if you were to buy stocks or their futures with a trading intention, the risk reward ratio is not exactly in your favour. Doing it with a call option is much better, where your risk is limited.
Buying futures and putting a reasonable stop loss also limits your loss, but it takes away the opportunity to participate in any upside, once your stop loss is triggered. Whereas buying a call option would keep you in the reckoning for the duration of the series.
There are times when no matter how much you study, you can't take a view. Take the issue of RNRL and RIL. First, you don't know what the court judgement will be like. Second, you don't know for sure whether the judgement will be given on the scheduled date or postponed.
These are classic cases where option is the better way of playing the stock you are backing.
The road ahead is full of ifs and buts. Options make sense in this kind of market. The Nuclear Suppliers Group will meet on August 21 and 22 to consider giving clearance to India. Five of the 45 members who have reservations on the matter may not want to be seen relenting too easily.
So a second meeting may be required in the first week of September. That suddenly shifts the action to the next settlement.
The markets' expectation that the regulator would revisit the curbs put in place in October 2007 has also not materialised.
Crude too has stopped falling. The ban on short selling in select 19 stocks, put in place by the SEC in July and given an extension till August 12, has also come to an end.
We have seen open interest in stock futures rising by 21 crore shares, as of Wednesday. This is the highest we have seen in 2008, at this stage of the current series.
This indicates that people have actively built positions in anticipation. My sense is that when the assumptions under which these positions were built, whether national or international, have changed, these positions could rewind, forcing the stocks to falter in the process.
There is another data that buttresses my point. The open interest (OI) of around Rs 78,000 crore (Rs 780 billion), as of Wednesday, is seemingly lower by around 40 per cent from the record open interest seen in January 2008; the lower volumes now would need around 1.6 days to unwind.
Effectively speaking, this is the highest inventory of OI that we have ever seen built in relation to volumes.
It makes sense to buy puts for the current series. In the beginning of September you may change stance and become a bull and buy call options. That would require a fresh re-assessment at that point.
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