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Optionalysis: MA20 Indicates a Trade, But Our Calls Have Already Doubled

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The MA20 has given us a signal – go long, it says.

The CAPM MA20 is our proprietary breadth indicator. We take total number of Nifty stocks above their 20 day moving averages, and subtract the number of Nifty stocks below their 20 day moving averages. That resulting number is smoothed for volatility and we get the MA20. This oscillates between +50 (all stocks above) and -50 (all stocks below). We have found that the move from below -30 to above, or from above +30 to below is a strong indicator of short term trend.

And now, we’ve just had a signal- the cross from below -30 to plus.

MA20

However the CAPM MA5 – which is the same as the MA20 except we use the 5 day moving averages – is at the other extreme already. This usually indicates short term flat behaviour on the index.

MA5

What’s the signal then?

• Usually we would play this using purchased call options, but given the “divergence” between MA20 and MA5, we’d tread carefully. (Plus, we already have call options we spoke about, which have since doubled)

• Given the RBI meet is tomorrow, option prices will fall after the meeting.

• The best thing to do, if you aren’t already long with calls, would be: Buy 8700 calls (Rs. 111) and sell 8900 calls (Rs. 36) for a bull call spread

Our last move on this was recommendation to buy 8600 calls which have since doubled, from Rs. 80 to Rs. 170. We mentioned booking half on the group, so that the rest are “free”. If you’re on that trade, there’s no point putting the call spread on, just ride the rest of the calls.

We also mentioned a higher risk trade: a 8600 and 8300 strangle. (Calls on the former and puts on the latter). This had cost Rs. 160 in our last post (two weeks back) and it’s now already up to Rs.195.  This would probably be a good time to exit. But you can choose to do this part by part, after the RBI move on Tuesday. If it cuts rates, exit the puts first and ride the calls. If it doesn’t, then exit the calls as stocks may recoil in disappointment.

Options are typically short term plays, so please excuse the myopic nature of these posts. Options are not for everyone, and our past posts will tell you that the position sizing and timing is more important here than anywhere else. Typical trades on the MA20 happen about once a month, and have been reasonably profitable.

We bought put options in November as the MA20 started going down, and sold them for a 3x return in December. More puts in February when the MA20 was going down again, for a quick return of 1.6x when we were done.

This is the third time this signal’s been right and we’re not yet done with this position. We have back tested this for a long time and it does throw up good opportunities, but which are relatively spaced out (so you don’t get a trade every day). But tread very carefully and do not allow a single trade to lose more than 2% of your portfolio. 

Note: We have some leftover positions but are no longer actively trading these instruments due to SEBI regulations. We will still remain very responsible for our trading suggestions, as we always have been.

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Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion. 

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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