March 2011 Summary

This monthly update is coming a bit late. Well, I have been watching the charts a lot more eagerly these days, since the markets broke out from a region of consolidation to start a new uptrend.

This was a mixed month for me. I made quite a lot of long term investments in my investment account. There is an ocean of difference in my confidence when I'm placing an order in my investment account, and when I'm placing an order in my trading account. Investing is fun, provided you have the patience to see your money growing. 
And since the markets broke away from the consolidation phase, most of my investments have already started to show decent gains.

But for trading, it was a horrendous month for me. I had just one decent trade, and that too a 5th wave trade.

Here are some disasters, which others may avoid after learning from me.

Titan:

I tried positional trading in Titan. But, I placed my SLO too close, and got stopped out. I was kicking myself, when I saw that Titan has gone up by more than 10% from where I got stopped out. 8% of which came in 1 day.
Lesson learnt :
Its better that a positional trader buy in cash segment and not in futures or options.
Once in the trade, the SLOs have to be placed pretty far away, just under a major support.

Cairn:

This was the only profitable trade for me. I got a slightly late entry into this. But, the upmove was extremely slow. On careful analysis, I found that the best part of the rally was almost over, and then I had traded that pullback.
Hence, the profits were too small. Not much to learn from this trade.


Wipro:

This is one of the classic cases where I  run a 100 metre sprint, in the opposite direction 30 minutes before the starting gun.
The loss was small, but good lesson to be learnt.
Always take an entry when the selling wave is over, or about to be over. Usually stocks consolidate in a tight range for a while before reversing their direction. Watch for this consolidation in the 5 min and 30 min chart and then enter the trade. In other words,wait for the trade to come to you.


Sesa Goa, Hindalco:

I shorted these 2 stocks in Futures segment almost simultaneously.  Both of them showed good signs of reversal, were overbought and were at significant resistances.
But what I had not accounted for, was that there were multiple up days before the day I got into the trade, where the volumes were above normal.And the fact that the overall markets were changing direction and these stocks are index stocks, added to the explosiveness of the rally.
I had to take major losses in this combined trade. But valuable lessons to be learnt.

Discipline and extreme money management are always of highest importance. I was in some training, so had not placed a SLO. In the first 30 minutes, both Sesa Goa and Hindalco went up by 2-3% each. In the normal case, my SLO would have hit, and I would have exited with minor losses. But since I hadn't placed one, I had to take the double of the losses that I am usually prepared to take as part of my trading plan.

Waiting for a trade till the reversal occurs is also important. In this case, I just plunged into a trade with bothering to see if a strong reversal had taken place.

Shree Renuka Sugars:
This was a shorting trade, where I took a very small loss, even though the trade moved in my favor. I saw Renuka touching a zone of resistance near the 30 EMA line. I got greedy and took 4 lots of PUTs paying a very small premium. I expected a quick breakdown. But, since this was at the end of the selling waves, it fell about 6%, but very very slowly. As a result, the gain in my options contract was offset by the reduction in its time value.
On expiry day, though Renuka closed just below the Strike Price, it didn't close low enough that I make a profit in it.

Lesson learnt : Options is an option only when the markets are trending well. When the trend has weakened, its better to trade in futures.

Overall, it was a bad month, hope April doesn't make a fool out of me.

Happy Trading !

Futures and Options Part 2

The last post was all about the basics about the class of derivatives called Futures, in a way in which I understood it. I hope folks who read this also understood it to a great extent.


Taking a futures contract is like making an obligation. As the name suggests, Options gives you options.
There are 2 types of Options, Call Options and Put Options. I'll talk about them one by one. 

First lets talk about Call Options.

This is a derivative contract that's highly traded in bullish times.
Say on the first of April, I find that TCS has corrected a lot to Rs.1080, and I find this a good price to buy it. With Options you can choose to buy a stock at preset values known as Strike Prices. For TCS, the strikes are defined at every 50 rupee interval. So you have strike prices at Rs.1000,Rs.1050, Rs.1100 and so on.

The lot size for TCS is 250, as the notional value would then be Rs.1100 * 250 = Rs.275000, which is greater than the minimum Rs.2 lakh notional value required by NSE.

I check that the liquidity in 1050 Call Option is not that great. So I decide to buy a Call Option for 1100 Strike Price. For this I am required to pay a premium of Rs.30 per share(just an illustration). As a result, I pay a total of Rs.7500 as premium. I buy this call option from a trader working for Morgan FIT, through the NSE. In the real world, since this happens through the exchange, I don't know who has sold me the option.A person who sells an Option contract is known as a Options writer.
 
By buying this Call option, I now have the right, but not the obligation to buy 1 lot of TCS shares by the end of April.

So how's money made in this?
Say now, TCS starts to rally hard and touches Rs.1200 within a few days. Theoretically, for every rupee increase in TCS's share price above 1130(accounting for the premium that I paid initially), the value of the contract increases by 1 rupee. There's a time value also associated with it. A complex differential equation developed using Black Scholes method governs this, so we can conveniently ignore it, for we don't make money by solving it.

So the value of the contract now stands at Rs.110 or so. Rs.70 being contributed by TCS's share price and Rs.40 contributed by the time value.
Now, in order to realize the profits, I have three options.
1. I can now sell this contract to someone else at Rs.110 and make a decent profit of Rs.80 per share, which comes to Rs.20000.
2. At any time, I can also choose to exercise my Option. But this is a bit of a risk, as now all Stock Options are settled European style. Which means that even if I exercise my option on the 5th of the month, the contract will only be settled at the closing price on the day of F&O expiry.
So, if I exercise my option on 5th and on the day of F&O expiry TCS falls down to anything under Rs.1100, I lose the entire premium that I had initially paid.
3. I can also wait till F&O expiry day. I get to earn the difference between the closing price of TCS and the Strike Price. Say, if it closes at 1200, then I get to earn Rs.70 per share. Note that at the end of the month the contract has lost all its time value.
That's the reason why most traders choose to make money through option 1.


As of now, all Options are settled in cash, which means that on expiry day I don't get possession of 250 shares for which I would have to arrange Rs.275000. Instead, I get the difference between the Strike Price and the closing price. If TCS closes below Rs.1100 I lose just the premium that I initially paid. Buying Options is a limited loss unlimited gains strategy.

The buyer of a Call Option has the right but not the obligation to buy the underlying security. But on the other hand, the seller of a Call option(i.e. Call Writer) has the obligation to sell the underlying asset at the Strike Price.
So, now the question is, how does the Call Writer make money in this. Well, large institutions try to hedge a part of their large stock holdings by selling Call Options. For example, they would have bought some 200000 shares of TCS at Rs.1050 and they would want to have an insurance to sell some 20000 of them at Rs.1100.


There are many other traders, even large institutions who sell Calls with a slightly ulterior motive as well. They see that Rs.1100 is a key resistance for TCS. So, the moment TCS approaches Rs.1100 there is a good supply of stock and the price drastically falls below the strike price. At the end of the month, TCS is still below Rs.1100 and the seller of the Call smartly pockets the premium.

Its my sincere suggestion for all the followers of my blog to stick to buying calls and puts, and leave the selling of options to large traders, and institutional traders who have all the resources to make the market in the direction that they want.

Now coming to Put Options.

This is a derivative contract that's traded heavily in bearish times. And just like Call Options, they are used both for hedging as well as speculative trading.

Say, the market has rallied nicely for 6 months now, and ICICI bank has been one of the major contributors to it. And I happened to have 250 shares of it, which I bought at Rs.800 or so, at the beginning of the bull run. Currently, its trading at Rs.1060 and I have strange feeling that it might fall badly, maybe well below Rs.900. So I decide to hedge it, by buying a Put Option at Strike Price of 1000, paying a premium of Rs.20 per share, that comes to Rs.5000.
So theoretically, for every rupee fall of ICICI below Rs.980, the value of my contract increases by 1 rupee. My hunch was right and ICICI bank falls to Rs.890 in a few days' time. In the normal case, I would have panicked looking at such a fall. But now that I have the insurance by way of this Put Option, I don't  need to worry at all.
The value of my Put contract would have reached Rs.120 or so now. In this case too, I can choose 1 of the 3 options similar to what I had in the Call options scenario. I make a decent amount of Rs.100 per share, that comes to Rs.20000. Now,I can use this money to buy some more shares of ICICI and also keep the shares of ICICI for myself.

If ICICI didn't close below Rs.1000 this month, then all I lose is the premium amount, which is not much when compared to the initial investment that I made in ICICI.

I could use Put Options purely as a speculative instrument too. As I don't have to really own the shares of ICICI at any point of time, and still buy a Put Contract.

Till now I have spoken mostly about Stock Options. There is a class of options called Index Options, where you can speculate on the different indices. The mostly heavily traded amongst all options are the Nifty Call and Put Options.

In this case, the Strike Prices are defined at 100 point interval, and the lot size fixed at 50.Its like having an option to buy or sell 50 shares of Nifty itself. If you multiply the current price of Nifty with the lot size, you will see that notional value is also greater than Rs.2 lakhs.

Nifty call Options is mostly a speculative instrument. But on the other hand, Nifty Put Options are both speculative and a hedging instrument.

Say, you have a fairly well diversified portfolio of stocks with a greater allocation to index stocks. You figure that the situation is going to get bearish. All you need to do, is buy a number of lots of Nifty Put Options at an affordable price and a likely Strike Price below which Nifty might fall to.
Say if your portfolio is worth Rs.10 lakhs, roughly you need to buy 3 lots of Nifty Put Options. Say today Nifty closed at 5908, and you see that the nearest support is at 5600. So you can take Put Option for 5800 Strike Price at the prevailing market price.

By the end of the month, if Nifty tanks to below 5600, then the value of your contract would have increased to an extent that it nearly offsets the losses that you would have possibly seen due to the fall in your portfolio. On the other hand if Nifty rallies, then all you lose is the premium. Its just like taking a vehicle insurance, isn't it?
This is the reason that bigtime traders and institutions never lose much money, even in the worst of bearish times.


This was about my understanding of Options. There's a lot more to all this. In fact you can even predict in which direction the markets might move, the possible supports and resistances by just looking at the Options charts. Maybe, in some other post. And maybe only if there's public demand to it.

Happy Trading !