Playing the markets via Put spread

Hi folks,

Its funny to hear the opinions again. Everyone wants to believe the market is oversold. Well, it may be oversold but then for the entire 2010, this market was overbought, why can't it remain oversold for 3-6 months, if not longer?

Now, if you have been watching Markets Mid Day on CNBC-TV18, I have been talking about the options data in great details. It's a folly to just take massive build up at a 5300 Put as some support level or a 5400 Call build-up as massive call writing. The fact is that options are presenting a beautiful trading instrument and believe me, you would have made more money in this market by playing with Puts, then you would have made on your stocks in a bull market.

What essentially is a Put spread? The Put spread is buying a higher strike Put and selling a lower strike Put. The premium for the higher strike price is always higher than the lower strike Put. So while you buy the higher strike Put, to compensate for the premium you pay, you also sell a lower strike one. This limits your losses if your directional call goes wrong, though it also limits your profit. But the risk-reward has been just too strong.

Last week, the spread that was giving the highest juice was buying the 5500 Put and selling the 5300 Put. It swiftly moved to the combination of 5400-5200 and yesterday it was 5300-5100 combination.

Let me explain this in numbers. The 5300 Put is available at Rs 87 and 5100 Put at Rs 29. If you buy the 5300 Put and sell the 5100 Put, your total premium outgo will be Rs 58. So that's your maximum loss, in case the markets were to go up from here. Your profit potential on the other hand is Rs 142. That's a very favourable risk reward in a market which is inherently weak.

Conclusion: The market remains a Sell on rally market. The bigger the rally, the higher the opportunity. But the time for going whole hog has gone, play the market via Puts in smaller lots.