How to Manage Volatility post-September 2021?
For the past few weeks, I have received a lot of DM from fellow traders who are struggling with volatility in Nifty or Bank Nifty. Following scenarios have happened with me too:
Profitable credit spreads suddenly turn into loss due to volatility
Even Iron Fly like positions are not experiencing theta decay
Theta Decay reverses the next day before profit can be booked
Mark to Mark hits SL or worst-case scenario before showing any theta decay
V-up recoveries and Flash sell are causing losses
The whole premise of Options Trading is that I try to predict where the market will not expire and strategize according to it. But in current volatility, analysis in predicting where the market may not expire might be correct but Volatility swings force me to close the trade because the mark to mark swing is huge. Even when I am hedged losses can be considerable when holding trade till expiry. And then suddenly when I make an exit, premiums start dropping my way leaving me further frustrated. At this point in time, even if I want to enter the positions again, there is no good premium left in the current expiry given the risk of Gamma towards the end of expiry. This pretty much sums up what's happening with me. This is how I am solving the problem now:
Market structure keeps on changing every few months. It has once again changed to high volatility now. Volatility and Chaotic movements are going to be way forward. Steller covid19 recovery has increased retail participation in the market. Not everyone can win so volatility will remain for a considerable time to come, forcing weak hands to liquidate their positions in loss. Amateurs who think market can give easy money will be taken to cleaners.
Even if my thinking is wrong, I have accepted the premise of point no. 1. I am not more risk-averse. My first rule of trading is further solidified i.e. to avoid taking a loss or take a trade that does not get into a loss easily even if I am wrong from the first trade. Even if I am wrong and my position is not going into loss; gives me the flexibility to correct my mistake without taking a capital burn.
Following are the pointers you can use to improve your trading in such times:
Reduce position size
Work with a SL
Create a strategy that is delta neutral, theta positive
Work on a systematic trading approach
Accept that you cannot predict where the market can expire
Have a targeted approach towards the market. If I am doing a credit spread, I know where my stop loss or getting out point is. If volatility is more, I reduce my position size. If I am doing Iron Fly, I have a set target of 80-120 points on Bank Nifty and 30-50 points on Nifty. If that is achieved, I take the profit and look for new opportunities. If I can not find a position, I shift to next expiry reducing gamma risk.
My approach is to reduce risk so that I don't get biased about the position and be flexible enough on when to change directions with the market.
Create credit spreads with good risk-reward. #BANKNIFTY is trading at 38200 and if a trader is bearish they create a bear call spread like this
Yes, you get OTM theta decay but gamma risk increases as you get close to expiry. A better way is to create a delta neutral, theta positive strategy with direction. Something like:
If you are confident about your direction but afraid to be near ATM strikes, reduce the quantity. But believe me, this will give you better hedging than the first position.
Or you can sell a call /put based on the direction with SL. Once it has moved in your favor, use the running profit to buy a hedge. Consider the example given in excel below. We sold Calls at 239 and 355 respectively. At the end of the day both were giving profit, we bought a hedge at end of the day. The next day the market turned and our position hit the stop loss. When we squared off, we were still in profit. Check how the sold calls were trading cost to cost but the hedge gave us profit.
As far as Iron Fly is concerned, I use Heiken Ashi on hourly charts for initiating a trade or adjustments. I do Iron Fly with a max loss vs max profit ratio of 1:2 or 1:3. If the maximum profit from Iron fly is 500 points then the max loss should be no more than 250 points. This way even during a volatile environment, the iron fly does not get into a loss. If the market remains sideways then whenever I achieve a target of 80-120 points, I exit. Target is somewhere 1/4 or 1/5 of max profit. If in between, I sense a direction is coming, I close the iron fly, create a new iron fly or then take credit spreads. Few examples.
At blue circle in below image, I created an Iron Fly expecting Bank Nifty to revolve around 39000 / rectangle area.
Few points from above example:
Check the risk:reward. It was close to 1:2
My target was 80-120. On Friday, I was getting 87 points, so I booked profit.
My expectation for the week was expiry in the upper range, but today's market is at 38200. If I had not booked profit, I might have ended in loss.
Following Monday, I again expected sideways movement and took the following position on Bank Nifty expecting market to be near 38700 to 38900 by week end since we are sideways.
Throughout the week, I did the following adjustments:
Yesterday, at closing time, HA was again bearish with MACD going bearish. My initial analysis was proven wrong that the market is sideways and I closed this position cost to cost without loss.
So in a nutshell, the answer to volatility is:
Reduce position size
Create Delta Neutral Theta Positive Strategies with good RR of 1:1 or at least 1:2
Have a target-based approach on SL and Target. Choppiness is the new normal in weekly expiries where nothing is set and SL can hit both sides.
Create a strategy that does not go into loss easily.
If you have to exit, the strategy should give you enough time to change direction at a breakeven exit.
Finally, do not hold an option because you think you are safe till the underlying is trading below your breakeven point. For eg. You sell a 60 Rs. call of 38900 when index is at 38400. Keep a SL. Just because your breakeven point is 38960, does not mean you have to wait for index to touch that point to exit. Things can go massively wrong this way. I have seen people blowing up accounts of 15+ Lakh with this thinking.
Hope this helps. Rohit Katwal