We do have opportunities where the fall seems just a bit overdone. Well, there are many ways in which most of us traders conclude that the down move has touched its extreme. The indicator could be as simple as previous significant low, or a bit complicated sentimental indicator.
No matter how we do it, but once we identify an opportunity of a possible bottom to be made around the current levels with a halt in the fall, we do need a trade to capitalise it. Now, just like me, I know most you are trend followers. Following on gong trend is a safer way to make money as well.
On the other hand, bargain hunting trades are specifically contra trades. They are opposite of trend following. This makes it even riskier. Eventually we end up avoiding it. This is where the art of bargain hunting comes into picture.
Once we sense that market is near a bottom, first define the immediate validity of that view. What I mean is the Stop Loss for the bargain hunting trade. Keeping margin of a percent or so, define before hand that as long as a particular lower-level holds, I will keep holding on to the bargain hunting trade.
Most of us with a risk of big loss try to play conservative on this part. I am saying be generous and give yourself and extra percent of Margin of Safety. This is the first change that one should be making in bargain hunting.
Secondly, make use of Options. Now, I know most of us must be using Options already. However, while using Options 2 Aspects need attention.
Aspect 1. Riskiness in the Options: Remember in falling market Option Premiums account for more risk (Obviously ). Notable here is that more accounting of risk mean higher will be the premium.
Now when we go ahead buying that Call for Bargain Hunting, in our winning trade market will rise and risk of falling will go down. This means, on one hand the rising market is making us money in Option Premium but falling risk in the market is reducing our profitability with its negative impact on premium.
Trick here is, to check premium of option that we buy just after 2-3 sessions if the underlying stock/ index does reverse and move towards your target with a fall in riskiness.
Method:
1. Find Implied Volatility (IV) of the option
2. Use Option Calculator: Re-Calculate your Option’s premium now with Input of
a. Spot Price = Your Target Price
b. Volatility = IV a.k.a riskiness in Option lowered by 10% (EG: 27% instead of current 30%)
c. Interest Rate & Dividend Yield = 0
d. Days to Expiry = Days Remaining after 2 days from Today to Expiry
Note: Both IV of an Option as well as Option Calculators are publicly available over internet
Such Recalculated Premium is showing at least decent 40-50% returns then it is a viable trade.
Aspect 2. Check your Premium Stop Loss as well calculating with similar Option Calculation technique with just 2 differences. While Calculating stop loss, remember to use your generous Stop Loss as Spot and do not use any reduction in IV for input Volatility. Reason being, with continuing fall we may not see drop in riskiness of the options.
Naturally, after a big fall the Stop Loss will be closer, and Target will be bigger in the underlying and so will it reflect in out Option Premium Target and Stop Loss as well eventually. But, with the calculation we at least approximate that we are trading with a reasonable risk reward.
Apart from these 2 Aspects, remember not to hold on to the option trade once the Premium Stop Loss is triggered. Since this remainder premium can be used if there an opportunity again.
Finally, the last and the best element of the Options is that we know all that we are going to lose. Now, God forbids if there is a big gap down fall due to some negative surprise overnight on the next day. We will not be pushed out of market due to this one courageous move.
On the other hand, with Options we can take each bargain hunting trade and not miss on any opportunity due to risk of losing a lot.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
