Monday, August 25, 2008

Volatility Falls as Market remains in range

On July 31, at the close of trading the Nifty was at 4332.05, Today, as the month & F&O settlement comes to an end soon, the Nifty closed at 4337. Thus, the index remained where it was after 25 days.
This is reflected in falling volatility. Historical Volatility (HV) is a decent enough measure of the presence or absence of volatile conditions. On July 31, HV was 50.9, today it is 29.81. The decerase in volatility is a reflection of the dull markets that we are in.
Low volatility means:
Less opportunities for day trading & swing trading since market moves are small.
Less opportunities to sell options since the premiums are low.
More opportunities to buy options since premiums are low. This is a double edged weapon, since the Index / Share may not move at all, thereby making even the low cost option into a total loss.
How low can volatility go ?
For the Nifty, the low band is around 20. Thus, volatility can continue to fall from 29 at persent to 20. This means we should expect more of the dull, range bound markets.
What comes after low volatility ?
The Market comes back to life after a period of low volatility. This could mean big moves, but the direction is unknown. Yet, by following the market, it is usually possible to determine the direction of the big move as it starts. Patience!
Actionable ideas:
Selling option spreads (inspite of low premiums) could bring in some revenue, since volatility may continue to fall. Do not sell naked options, because an explosion in volatility in the wrong direction can cause large losses.
After a few more days of low volatility and ranges, it may be worthwhile to buy option spreads - calls and puts both. Risk is that both of these could expire worthless if volatility remains low till end of september. The reward is a big jump in price of call or put if the market takes a directional jump. To balance the risk, invest only such amounts that you can easily accept as a total loss.
Watch the charts for early warning on the direction of the breakout from the low volatility zone. take small positions in that direction, with proper stops. Do not mind getting stopped out if the anticipated move does not occur. When it does move, your trade should become very rewarding.

1 comment:

Hemanta Gogoi said...

Dear Sudarshan,
Thank you very much for your blogs. Seeing you on TV you know we have high regards for you. Among the people we see, hear on TV I have a feeling that you are a person who call spade a spade. Not the likes claim to know each and every move of the market. I like the way you regard market, it is the way it is, neither right nor wrong, whether up or down.
Will criticize you later. Bue
Hemanta Kumar Gogoi