The Hindu Business Line : Index Strategy: Long straddle to play the volatility

Traders looking to play the volatility in the markets can consider setting a long straddle on Nifty 5,000 November series. This option spread can be set by buying Nifty 5,000 November put and call options, which are trading at Rs 91.5 and Rs 90.7 respectively. The spread would entail an initial outgo of about Rs 182 a share. Note that a long straddle derives strength from high volatility and or the likelihood of a decisive move in the underlying, which in this case is Nifty. Since technical pointers do indicate the possibility of a swing in either direction during the week, setting a straddle may help. Relatively high open interest on the puts side, suggesting excessive build up in short positions, may also help the Nifty make a crucial move.

Risk-return payoff

The maximum risk in this strategy is limited to money used to set the spread, in this case, Rs 182 a share if the market fails to move as expected. Though the upside potential is theoretically unlimited, note that the spread will turn in the money only if the Nifty breaches its breakeven points. These can be arrived at as follows:

Upper breakeven (5182) = Strike price (5000) + premium outflow (182)

Lower breakeven (4818) = Strike price (5000) - premium outflow (182)

This essentially means that your straddle will become profitable only when the index moves either above 5,182 or falls below 4,818. Between these two points, the position will suffer a range of losses with the maximum loss (limited to the premium outflow) at the strike price.

When to exit

If Nifty makes a decisive move beyond the breakeven point (either side), consider cutting the loss-making leg first, while leaving the profitable leg open so as to maximize the profits. Similarly, in case the index fails to move as expected, do not wait for too long to close the position. Though the maximum loss is limited to Rs 182, premature closure of the position would help in cutting losses.

More Stories on : Stock Markets | Derivatives Markets | Investments

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
ITC: Book Profits

Wait…. Signals getting stronger

Sundaram BNP Paribas S.M.I.L.E.: Invest

Birla Sun Life Dynamic Bond Fund: Invest

Cox and Kings (India) — IPO: Invest

Lloyd Electric & Engineering: Buy

Whirlpool of India: Buy

Unity Infraprojects: Buy

Chart Focus: Redington India (Rs 284.2): Buy

Query Corner: Exit from Vishal Info and Austral Coke

Index Outlook: Towards a new 2009 high

Stock Strategy: Weak trend seen in Tech Mahindra, JP Associates

Index Strategy: Long straddle to play the volatility

Honing stock-selection skills