Options-Based Trading Strategies for Limited-Range Markets
Stock markets tend to stay stuck in a range for long periods of time. Current events are easily linked. Many directional traders take a break during these periods because the huge moves are hard to spot in the limit markets and they are infrequent. For some reason, however, this type of market situation has always worked well for me. After the financial crisis of 2008, more than a decade ago, I started dealing with it on a regular basis. For nearly a year, the market has been stuck in a range. The lessons learned throughout this period still apply.
1. The highs and lows of a few weeks ago have not been broken (and sustained)
First, let’s understand how to spot a range bound market. If you have the following three characteristics visible in the stock market, you can reasonably call it range bound.
2. Open interest in Nifty Calls and Puts is nearly equal (publicly available information on NSE website)
Creating this policy is simple. Sell Call and Put of an exercise price closest to the CMP of the index. Being index-based, it is likely to be less volatile and there is sufficient liquidity as well. However, since put options have an unknown risk profile, we will add a few more options to this. I always have and would recommend buying Protection. In addition to put options, buy a higher-strength call option and a lower-strength put option. An easy way to choose the strike price is that the difference between the two buy prices could be equal to the total premium received by selling options.
3. India VIX has fallen over the past few weeks. Once it is established, we can treat and trade these market conditions as a range bound market.
Example: Clever @ 1000
Sell 1000 Call @ 50
Sell 1000 Put @ 50 Total premium received 100
Buy 1100 Call & Buy 900 Put for protection. The maximum profit would be the net premium received and the maximum loss would be the difference between the buy strike and the sell strike minus the net premium received. It is always best to define this economy well before entering the trade.
For individual stocks, we can also use options. However, we have to keep in mind that there will be a lack of big moves, so adjust trades accordingly. In addition, care must be taken that stocks and indices can continue to fall from the upper end of the range and rise from the lower end. To handle this,
1. When trading stock options, we could maintain our price target and stop smaller losses. 2. Take trades on single options (Call Buy/Put) for 1-2 days.
3. When we are close to the recent high, we have a mix of Buy Call & Buy Put (Bullish & Bearish) trades. The range bound market has an attractive feature of not having to commit to the trade for a longer period of time. History says that many small trades improve the probability of profit. So range-related markets are also also profitable, if traded effectively using options.
Summary of news:
- Options-Based Trading Strategies for Limited-Range Markets
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