Shubham Agarwal
Respite or relief rally as it is popularly known is one such move that has its own characteristics and requires few modifications from our usual buying strategies so that we don’t get caught on the wrong foot while trading them and end up giving more than what could gain.
We will look at 3 major characteristics of relief rallies and 3 simple modifications to adapt to the change in course taken by the relief rally.
1. Sharpness in the Move
Always keep in mind that relief rallies are not our constructive bull markets hence the moves are never slow. Most of the time we are presented with a spike followed by a very fast move. Now, such fast moves are hard to catch and tough to chase.
If we are halfway through (assuming), the move already in place will reduce our courage because remember we are still in a market that has been falling till now. So, need gets created for participating with the same confidence regardless of whatever stage of the relief rally we are at.
Modification #1: Move all your relief rally Buy Positions to Slightly Higher Strike a.k.a. Out of the Money Call Options. Benefit of this is that they are relatively inexpensive considering the exposure they provide. Smaller Premiums will never put you out of business since not a lot is at stake.
If the move sets in and as the Stock/Index comes closer to the call option strike, the premium of that call option will start rising at a faster pace, rewarding us for our courage. Most importantly, the inexpensiveness of the Out of the Money Calls will help you take the trade immediately without wanting to bargain and thereby be ready to capitalise on the Sharpness in the Move.
2. Risk of End of Relief Rally
Now generally once a trade is taken, we work with a stop loss feature in trading to make sure that once the trend reverses we get out. Here, the issue is that the moves are so sharp and the stop losses (pivotal point suggesting the relief rally is over) are so far away, it is difficult to keep a Stop Loss.
Modification #2: Simple way to handle this is that the already inexpensive option is held only for the day and is exited towards the end of the day. This could be done if the trade does not materialise. This means, the option is close to our entry price or is in a loss.
In case we are in slight profit and would want to continue holding on to it, there needs to be another modification. Since overnight carry-forward of such short-lived relief rallies is risky, I would generally go further out of the money and go higher up at least a couple of strikes than whatever I have bought and sell those even higher Calls before market closes.
Now, my profits are restricted to the strike of the Call Option sold by me. However, with one bought and one sold call, I can be at peace that I will not end up losing a lot.
3. What if Relief Rally Turns into Reversal
First of all, if the relief rally turns into reversal we will already be in a big profit. However, just in case we got the move really late, then we need to identify potential of a reversal happening.
Indication of this could be many including risk index India VIX going down significantly, market consolidating after posting gains for a day or so and, of course, if there is a known issue of that getting resolved.
Modification#3:
In such situations it is wise to convert the positions into futures. This is because the option premiums in upward reversals drop significantly due to a drop in the risk of fall in the market. So, it makes sense to turn buying into futures with stop loss instead of options.
I, however, do practice keeping a distant hedge handy. Even though we are going to rely on the stop-loss, I keep buy position in a lower put (probably strike = double the distance from my stop loss).
Example; Buy Stock at 100 SL 97.5 .. I will buy 95 Put also just in case.
These are some of the modifications one could resort to while trading relief rallies to trade them efficiently and with confidence.
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