Trading a blue sky
When there are no previous peaks to serve as a lighthouse, or as an obstacle, there is no limit to how far you can chase Nifty higher, except the ones imposed by you. Nifty has been walking this path, while making new and new peaks with frequent intervals.
Option strategies best suited for such markets are naked long calls, as any additional leg serves more to eat away the profits, than provide a hedge as intended. If your conviction of upsides is high, you could even do a combination of long at-the-money (ATM) call and short out of the money (OTM) put.
But we know that hidden away from the angle of view of the human eye, lies the clouds which can mar the blue sky. This has been especially so lately.
20 vs 21
While Nifty has been directional for the most part of 2020, this year has been dominated by episodes of sideways moves spanning several months. The first one of such episodes started as early as February and lasted three months, while the next, lasted two months through June and July. What this has meant is that traders who have been riding Nifty’s directional moves of 2020 or using it as a benchmark for their trades in mid and small caps became less expectant of large moves. This has reflected in VIX, a measure of volatility expectations, which has fallen to record lows, and more importantly stayed close to it for sustained periods.
Lose, even when you are correct
The main risk with playing sideways moves or low Implied Volatility (IV) environment, without knowing that you are in one of them, is that your premiums may not gain sufficiently, or even hand you losses, if you enter too close to the expiry, even though your view on the underlying was correct.
Well begun is half done
The advantages of starting well or getting the entry right, cannot be stressed enough even in normal trading conditions. In a low VIX environment, it is in fact essential to do so. To get the best shot at squeezing profits from a low VIX environment, it therefore becomes important to use strategies that rely more on non-directional cues like vega and theta. It is important to grasp the significance of these two greeks in the present environment. This is because, low volatility manifests as lower option pricing, and the directional conviction that usually aids us in the strategizing and decision making may not be helpful enough, making it essential to bring other elements into the mix, that can give us as much as edge as possible.
I would like to touch upon two of my go-to strategies in such a scenario:
The diagonal spread has similar features of the vertical spread, in terms of the ability to capture directional moves, but the different terms (calendar spread) help with positive vega.
That said, my personal preference is to sell straddles/strangles, but it requires closer management/repair than the vertical/calendar spreads.