The Long And Short Of Volatility And Methods To Still Be A Winner

In these days of volatile markets, there are still enough opportunities hidden to make money. Karan Bhojwani tells you how to woo a volatile market and smile

Stock markets irrespective of their locations, size and quantum of business are fascinating places for numerous with the fact that one can make a fortune by just tapping computer keys without changing locations. In order to make fortune in the stock markets, it’s important that stocks’ prices move up and down and price fluctuations thus help one to make fortunes from stock trading. There are however, different notches to which price fluctuations may occur. Sometime the characters of the markets are slow and steady, sometime the markets may move in simply one direction or move within a narrow range. On the other end of the spectrum, there are times when prices move with wild twist and turns. However, this phase of twist and turns is defined by the term ‘volatility’.

Investors define volatility as the relative rate at which the price of a security moves up and down. Volatility is measured by calculating the annualised standard deviation of daily change in the price. If the price of a stock moves up and down rapidly over short time periods, it has high volatility syndrome. If the price hardly changes, it has low volatility.

Like it’s said everything has its two sides, markets also have similar characteristics. The pro’s is that as volatility increases, the probability to make quick money also increases. The con’s is that as volatility increases so does the risk. In simple terms, volatility is an opportunity if you are on the right side of a move; on the other hand, it’s an adversity if things go the other way.

Yes, it is known as Indian VIX. Indian VIX is a volatility index which is a key measure of market expectation of near-term volatility conveyed by the Nifty stock index option prices. This volatility index is computed by NSE based on the order book of Nifty options. Indian VIX indicates the investors’ perception of the markets’ volatility in the near term i.e. over the next 30 calendar days.

Above is the chart of Indian VIX and its quite evident from the chart the VIX surged higher around 15^th January, 2016 since then markets have seen a vicious movement, however, currently it’s settling around levels of 17. 

Given the fierce outing market participants had encountered since the beginning of the year, a lot of them are now searching for methods to mitigate risk and keep volatile market forces at bay from causing turmoil on their funds. However, the methods which help to mitigate risk either have been a mysterious or stunningly complex for the retail traders. So here we will enrich the retail traders with few effective methods using the ‘option’ tool, which can be rewarding in the volatile phase for the stock markets.
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Strategy Used in Times of High Volatility

·        Long Straddle

·        Long Strangle

Have you ever had the feeling that a stock is likely to witness a big move, but which way the move is going to happen giving sleepless nights. But for an option trader this is where the real opportunities found. The Long Straddle option strategy is also known as a buy straddle or simply ‘Straddle’ strategy. This strategy is a combination of buying a call and buying a put option, with the same strike price and expiry. This strategy is employed by a trader when he is expecting a big move to take place in the price of the underlying asset but is not sure about the direction of the movement. This strategy involves buying of one lot of ‘at the money’ (ATM) put option and one lot of ‘at the money’ (ATM) call option. For example, consider that the Company ‘ABC’ is trading near Rs 210 levels and the trader is expecting that the stock will see a major move in the coming trading sessions on the back of some announcement in the stock. Considering this he will buy one lot of (ATM) 210 call option of ABC and simultaneously will buy one lot of (ATM) 210 put option of ABC.

Risk and Reward

Risk: In Long Straddle strategy the risk is limited; the maximum potential loss would be net premium paid at the outset i.e. Rs 12,250.

Reward: In this strategy the reward is unlimited; a large move in the stock price will result in higher profits. Maximum profit in this strategy would be obtained if the stock price moves higher up to levels of Rs 230 and on the downside the stock corrects up to levels of Rs 190.

What is a Long Strangle Strategy?

Another strategy which will help retail trader to take advantage of the volatile moves in the stock or index is the Long Strangle option strategy. This method is applied by a trader when he is expecting a big move to take place in the price of the underlined asset but is not sure about the direction of the movement. In this method a trader buys 1 lot of call option (out of money) and 1 lot of put option (out of money). For example, consider company ‘XYZ’ trading near Rs 730 levels and a trader is expecting a big move to happen in the stock on the back drop of some event or RBI policy. Considering this, he buys 1 lot of Yes Bank call option of 780 strike price and one lot of put option with strike price of 680.

In this strategy, a trader will pay total premium of Rs 4,937.5 i.e. 1 lot of 780 call option at Rs 9.05x250= 2,262.15 where 250 is the lot size of XYZ and Rs 9.05 is the premium of 780 strike price call option. Similarly, if we calculate for 680 put option the amount comes to Rs 2,675. So by adding the premium of both the options we get 4,937.5. In this strategy maximum loss is limited. The maximum loss occurs if the underlying stock remains between the strike prices until expiration i.e. 780 on the higher side and on the lower side 680. On the other hand, this strategy will be profitable if the stock price moves at or below Rs 660 on the lower side and on the higher side if the stock price moves at 800 or above. 

Risk: In Long Strangle strategy the risk is limited; the maximum potential loss would be net premium paid at the outset i.e. Rs 4,937.50.

Reward: In this strategy the reward is unlimited; a larger move in the stock price will result in higher profits. Maximum profit in this strategy would be obtained if the stock price moves higher up to levels of Rs 830 and on the downside the stock corrects up to levels of Rs 630.

Conclusion:

Apart from the above mentioned strategy, there are other strategies which are used during the volatile market situation; however, for the retail traders these strategies are effective and stress-free to start with as the primary goal of trader is to maximize profitability, while limiting the risk and these strategy helps the above cause as maximum loss is known before taking up the trade.