Many retail traders do NIFTY trading by predicting market directions, For instance, some retail traders are bullish on NIFTY and expecting NIFTY to rally after budget, others are bearish and predict NIFTY to touch 4600. These are directional trades and are very risky if done without hedge. Never trade NIFTY future without hedging as you may incur huge loss if NIFTY does not move as per your prediction. What is the solution for this problem? Can NIFTY be traded without knowing market direction? Yes, you can trade NIFTY options without predicting market direction. There are many strategies an option trader can pursue which are non-directional and can give decent profit. Classical example is selling out of the money options is one way of trading without predicting where the market direction.
If you are an option seller you may be know the advantages of time decay as a factor in non-directional trading. There are numerous occasions where the market moves unfavorably to your position but your trade still ends up a winning one because the passage of time eroded the value of the option.
Let’s take a quick look at how this is possible. On Feb 1, 2010, NIFTY spot value was 4899.70. Let’s assume that at the close of the day we sold a 4900 call@117 (short) and bought the 5000 call @72(long). We collected Rs. 2250, excluding commissions and fees, while constructing a call spread, which provides us with limited, pre-determined risk.
There are 100 ways to depart your girl friend but there are only 5 ways NIFTY can move from here.
1) NIFTY can stay range bound and trade between 4800 and 4900. 2) Enter a slow bearish trend reaching, at expiration, the 4700 level. 3) Enter a strong bearish trend expiring well below the 4700 level. 4) Enter a slow bullish trend expiring at the 4950 level. 5) Enter a strong bullish trend expiring above 4950. As the seller of this spread you may profit in four out of the five possible scenarios. In case of directional trade, probability is 50:50(up or down) but here it’s very low. Only a strong bullish trend, which will bring the underlying market well past your short option strike price at expiration, will turn this spread into a losing one. Any of the other four scenarios will make your trade a winner at expiration.
Trouble for option sellers arises if the market without a doubt enters a strong trend adverse to your position. But what if you could trade in such a way that would minimize your dependency on market moves? Delta Neutral trading is precisely that. Indeed, in any system of trading there is a little thought, as small as it may be, to direction? Delta Neutral, while indeed influenced by quick moves or gapping markets, attempts to minimize the affect of such market movement on your position and focuses on profiting mostly from the one aspect all option sellers look for – time decay.
Narendar Rathod, Options Strategist, www.assuredgain.com