Vijay  Bhambwani's  page - updated monthly

                                Ideas on risk free returns - July 20, 2003                   

We all look for monetary gratification from the markets and that sole consideration keeps bringing us back to the stock markets - whether we make money or lose !!! It would obviously be desirable though not entirely easy that we make money more often than lose it. It would fatten our bank balances, help our personal bottomlines and keep the home fires burning. So in this article, I will write about a strategies that will make us some relatively low risk / high profit trades and that too in the short term !!

I have advocated in my previous articles that the Nifty will encounter resistance at the 1180-85 levels, the Sensex at 3750 levels and that is exactly what has happened. Thanks to the information age, a majority of investors / traders knew of these levels - it was written about in most papers, spoken about on TV and referred in many an online chat interview by many a analyst. So wide was this perception that every stock trader worth his / her salt waited at near these levels for the next guy to buy stocks to take the levels beyond these congestion bands. The result - the markets slumped for the want of buying support !! Since buying was propelled by greed, selling propelled by fear - fear that if one did not sell today, tomorrow would bring more grief and losses.

It is very likely that the markets are going to see high volatility till the expiry of this month's derivatives series and the mood will be laced with optimism and hope - hope that the markets will revive sooner rather than later. However, I don't foresee huge buying by retail investors which will push the markets significantly higher. An average investor is not yet ready to sell at a loss also. The scenario points out to a clear picture - there is unlikely to be a major fall in the short term, however, at higher levels, investors / traders don't mind selling at breakeven points to unlock cash. Which means that the markets are likely to seek a direction and will also range-bound with limited upsides.

What if there was some way of making money in a hazy scenario like this ? That too with lower relative risk AND in the absolute short term ? Well, there is a way - options trading with a difference. We all are so stuck up with the idea of BUYING options and paying a premium, thinking that our losses are limited to the premium that we pay, that it seldom strikes us to do the exact opposite !!! It is a globally known fact that over 80 % of options expire worthless, especially in high interest rate regimes where the premia is higher due to interest calculations. Since someone is buying options and paying a premium, there must be someone selling these options and GETTING these premiums. Since more than 80 % of these options expire worthless, the premiums collected are in crores of rupees !! It is therefore a simple matter of playing the game from the right side of the fence. 

As an options buyer, you pay only the premium. As an options writer ( seller ) you also pay a margin as you are liable to honour your commitments. It is the options buyers prerogative whether to exercise the option or not - a seller is to remain prepared for any such eventuality. Therefore exchanges collect margins from options sellers. Then you RECEIVE a premium from the buyer ( remember the good old badla days when bears received "vyaj badla" from bulls ?) and depending on the strike price and the premium ruling at the time of the trade initiation, you calculate the rate of return on capital deployed by way of margins.

Let us take a theoretical example -

As on July 19 2003, Hind Lever closes at Rs 152. The outlook for the counter is bearish as the institutional investors are selling the stock. It is unlikely that the counter reverses it's current trend and close significantly higher on July 31, 2003 which is the derivatives expiry day. So we pick a safe and secure strike price of 170 in the July series and sell a call. You are going short by selling calls and collecting a premium of Rs 1.55 per share ( closing call option price as on July 19, 2003 ) the mechanics are as under - 

Strike price 170 - July series
Contract size = 1,000 shares
Margin deployed = Rs 28,000
call premium Rs 1.55 per share / Rs 1,550 per contracts
No of days of investment = 9
Rate of return = 5.5 % absolute OR 17.5 % p.m OR 210 % annualised

As we have shorted HLL at a strike of 170, we are set to lose money ONLY if HLL closes above 170 as on July 31, 2003 - which seems a little far fetched at this point of time. It would make sense to wait till the expiry day after initiating this trade to realise the benefit of this system. Though the amount of money earned is limited, it is qualitatively a more sensible approach as the risk is controlled and so is the stress level. 

I shall be back with more such ideas - till then, have a profitable day !!!

Vijay Bhambwani

Your feedback is important ! Please click here to let us know your views. Click here to inform a friend about this page on our website.