Strategies for range bound market

It ‘s relatively easy to make money in a trending market. It is much more frustrating to manage range trading situations such as the current one. Many standard technical indicators give false signals during range-trading.

When there ‘s no clear trend, the trader must change methods. Few of the possible alternatives is very satisfactory. One possibility is to trade within the range itself, going short near the top and long at the bottom. Swing traders do this. It involves more trades, higher brokerage and higher error rates due to frequent reversals. Also, the trader must use different indicators and recalibrate position sizes, stop-losses, etc.

Range trading is however, a reasonable situation for an option trader. Options are versatile enough to handle both trending situations as well as choppy periods. If there ‘s sufficient depth in the options market, it ‘s possible to sell options that are far from the money to make a profit from the premium. If naked short option positions seem too risky, they can be covered by long options further from money.

For example, if the trader thinks that Nifty 5,800 and Nifty 6,300 are sufficiently far from money not to be hit in the October settlement, he could sell a 5,800p (15) and a 6,300c (22) (both Oct). He hopes to keep the premium if the short strangle expires out of the money. The risk is that these are naked shorts.

A safer strategy is to take a long (or short) position in the futures market and sell calls (puts if you ‘re short) in the same underlying. For example, sell the Nifty 6,200c (51) and buy a long Nifty future. If the market does trend up, the futures position gains. If it doesn ‘t trend, the premium from the short option position will be retained as profit.

Another method is to “buy time “ via an option calendar spread. This involves taking the same strikes in opposed directions in consecutive months. Suppose a trader has a long-term bullish perspective but sees the current situation as range trading. He could take a short October 6,300c (22) and a long November 6,300c (90) at a net costs of 68.

If 6,300 is hit in the October settlement, both options rise in price. If it isn ‘t hit, the trader has bought a cheap long-term call.

A similar calendar spread in puts is equally possible. This would be an indicated strategy if the trader thinks the market will fall. For example, a short Oct 5,900p (27) and a long Nov 5,900p (84) can be taken at a net cost of 57. The logic is the same. If 5,900 is struck in October, the November put will also gain in value. If October expires without being struck, the November put is held cheap.

The author is a technical and equity analyst