Performance cycles can harness event risk such as the Budget and offer an alternative strategy.
What should have been or should be the Budget strategy? If you would have heard the budget analysis, you would not have to think much. “Markets like it” was the overused phrase, between all the direct tax and fiscal reform talk. Whether markets really like it more than the budget day will be clear soon. But what is important is to understand that event is not just about news characteristics, but also about risk.
A few investors asked to brainstorm on the above question thought like this. One thought of the Nifty contracting triangle and suggested staying away. Another suggested range-bound Nifty was good between 4,900–4,700 and selling puts and calls and taking premium. A third talked about a March straddle 30 minutes before expiration.
As intelligent as the above debate might sound, never short a naked option before an event risk. Budget is an event risk. Don’t try to be a hero. Shorting a naked options offer the classic tradeoff between premium and risk. Too much focus on premium is a strategy of being wiped out. I don’t have to tell you how much a naked option can move against you and how much it can make you feel like the king of good times.
Ok, I am sounding like Taleb here. There are great ideas in his work though I strongly disagree with the one with randomness. The reason I am talking about avoiding the short side is because the retail investor typically is not aware of all the risks.
Learning risk
There is a difference between being a forecasting service and running an advisory. As we transform Orpheus, moving from the former to the latter, it is risk containment that takes most our attention.I remember receiving a mail from Dr C K Narayan, who did not like the tone of my article in 2002. He told me that I needed to increase my respect for the market. This was valuable advice that stayed with me. Then there was my business school batch mate Harsh Gupta, an Indian banker based out of Dubai. In my early years in 1999 he used to give me an occasional feedback on my work.
He told me to always have an exit door in a forecast or strategy. At first I did not like it. It sounded like an escape door. But his idea was that even if I was sure, the exit door was prudence. Well I stopped using the phrase ‘will happen’ and replaced it with ‘should happen’
Even if time is certain our interpretation of it will always be uncertain. Like it or not, there is nothing like 100 per cent probability, a forecast or a strategy even if you knew the budget speech. That was an old investment world where early news was total. Markets are more complex than access to information.
Betting on volatility and theta
Yes agreed that events do bring volatility.
But how much do you understand the Nifty Vix. IV’s (Implied Volatility) have moved up from sub-20 levels to 31 now, which means the costs of playing on volatility have already gone up. So your classic straddles are already expensive.
“Ok fine” you may say, I get the idea of riskiness of shorts, costliness of straddles and complexity of IV, “I will play beyond the budget and carry my exposure well into March”. This is where you should not forget that option premiums decay with every passing second. The idea is that a retail investor strategy should reflect more than his belief in his stars, his broker’s stars and of course the event excitement.
The performance cycle strategy
Grasim was at the top of alpha numeric rankings last week. And according to performance cycles the top ranked stock will underperform. The Orpheus strategy is to buy the Nifty Bees and short an equivalent value of Grasim futures against it. This way we carry the strategy well into March without option premium decay. We neutralize statistical volatility a bit and we assume that any trend, up or down will hurt Grasim outperformance against Nifty.
Our best wishes are with the FM to bring in solid, structural changes for the Indian economy and for markets to give thumbs up beyond the solo budget day. However, irrespective of what has been mentioned and how investing community interprets it, technology, banks, and capital good sectors should underperform the Sensex and BSE Oil, metals and small cap is where one should be for relative outperformance.
The author is CEO, Orpheus Capitals, a global alternative research firm
