In today’s special blog, I am excited to share some valuable information about options trading in stocks. Through extensive research, I have discovered a concept called seasonality, which is not widely discussed on the internet. I will explain the concept of seasonality and its application in trading, focusing on Nifty, Bank Nifty, and EOA index, as well as different sectors and stocks.
Seasonality refers to the patterns or trends that occur within specific time periods, such as months, in the stock market. By analyzing data spanning 10, 15, or 20 years, we can determine which months perform well for Nifty, Bank Nifty, and various sectors like auto and pharma stocks. This understanding of seasonality can help traders make informed decisions about when to buy or sell options.
It is crucial to practice and explore the research steps on your own to fully grasp the concept. Let’s dive into the process.
Once you access the application, search for “seasonality” or “price seasonality.” This will lead you to a page with various data and options. It can be overwhelming, so I recommend saving this blog and following along with the steps mentioned here to avoid confusion.
For now, let’s focus on the “price seasonality” section. By clicking on the “table view” option, you will see a comprehensive table displaying data for the past 15 years. I will guide you in interpreting the colors on the table to make it easier for you.
Green indicates a market increase, while red represents a market decline. Dark green signifies a significant market growth, and dark red indicates a significant market decline. It is important to note that the year 2019-20 was exceptional, so you can exclude it from your analysis.
Here, we have explored the concept of seasonality in the stock market by analyzing average monthly returns over a period of 15 years. While it is essential to consider the impact of exceptional events like COVID-19, the 15-year data provides a broader perspective.
We observed that Nifty’s performance in January is generally negative, with an average return of -1.27% in February. However, March, April, and May show positive returns, indicating a favorable period for Nifty. Additionally, June and July also exhibit positive returns, with July standing out as a month with a 2.59% increase in Nifty over the past 15 years. Even when considering a 10-year data set, July’s average returns for Nifty are significant at 3.58%, surpassing the average June returns of less than 1%.
By understanding seasonality, we can anticipate potential market movements. For instance, if we are making this blog in June, it is crucial to recognize that July historically experiences higher average returns for Nifty. It is essential to analyze past trends to gain insights into what might happen in the future.
The data from the last 10 years highlights the varying performance of Nifty in July, with returns ranging from 9% in 2022 to -6% in 2019. This demonstrates the importance of considering seasonality on an annual basis.
In a similar manner, if we shift our focus to Bank Nifty, we observe exceptional returns in July, surpassing the performance of the entire year. July records an average return of 3.24%, indicating a significant increase compared to other months. This further emphasizes the relevance of seasonality in trading decisions.
Specifically, we will focus on a 3% move in the Bank Nifty, which translates to more than 1000 points in a positive direction, given the current level of 44000. By analyzing historical data, we can identify months that are not favorable for Bank Nifty, such as January and February, as well as September when it generally experiences a 2% decline. This information can help traders make informed decisions and assess potential opportunities.
Moving beyond index analysis, sector analysis plays a crucial role in trading stocks. Therefore, before delving into individual stocks, conducting sector analysis is essential. By examining which months a sector tends to perform well or poorly, we can once again apply the concept of seasonality. Let’s take the example of the pharma sector. Analyzing 10 years of data, we find that January and February are generally unfavorable for pharma stocks. However, in April, there is an average return of 6%. It is interesting to compare this historical data with the current year’s performance. For instance, in January and February, pharma stocks experienced a decline of 2% and 4% respectively. In March, the average return was 1%, but this year it recorded a substantial 23% increase. Similarly, in April, pharma stocks historically exhibit a 6% gain, but this year it witnessed a 7% decline. This analysis provides valuable insights into how pharma stocks have aligned with historical seasonality trends.
The concept of seasonality can be an incredible tool for formulating a trading view. It is important to conduct sector analysis to identify the months when specific sectors perform well or poorly. For example, while pharma stocks tend to excel in July, the power sector historically records a 1.52% return. By conducting research spanning 10-15 years, traders can gain a deeper understanding of sector-specific trends.
To make informed investment decisions, it is crucial to look into individual stocks within each sector. For instance, in the reality sector, historical data reveals exceptional returns in July. However, stocks in this sector tend to decline in August and September. By identifying the specific stocks within these sectors, such as DLF, traders can further refine their trading strategies.
For example, we discovered that the auto ANC sector tends to provide a 5.17% return in July. To further refine our analysis, it is crucial to identify the specific companies within these sectors. By using the built-up scripts feature in the search function, we can easily find the stocks associated with a particular sector, such as auto ANC or pharma.
However, understanding seasonality alone is not sufficient for making trading decisions. We need to consider other important factors as well. One such factor is liquidity, which often discourages traders from investing in individual stocks. Liquidity refers to the ease of buying and selling a stock without significant price fluctuations. If a stock has low liquidity, it may be challenging to execute trades and may result in unfavorable prices.
To overcome this issue, we can use the liquidity finder tool to identify stocks with high liquidity ratings. By selecting stocks with a four-star liquidity rating, we can ensure better trade execution and minimize bid-ask spreads. High liquidity stocks allow for smoother transactions and reduce the risk of price disparities between buying and selling.
While conducting sector analysis and identifying stocks with high liquidity are crucial steps, it is important to note that trading options based solely on price movements can be risky. Instead of blindly buying call options when prices are expected to increase, it is advisable to employ a more comprehensive options trading strategy. The reasons for this caution lie in two factors: IV (Implied Volatility) and liquidity.
IV refers to the market’s expectations of future price volatility, affecting option premiums. It is essential to consider IV when trading options, as higher IV can inflate premiums, potentially reducing the profitability of trades.
Moreover, liquidity plays a vital role in options trading. Low liquidity can lead to wider bid-ask spreads, making it more challenging to buy or sell options at desirable prices. Therefore, trading options in stocks with higher liquidity reduces the risk of encountering liquidity-related issues.
By taking these factors into account, conducting thorough analysis of sectors, identifying stocks with high liquidity, and employing a comprehensive options trading strategy, traders can make more informed decisions and increase their chances of success.
In options trading, understanding the concept of implied volatility (IV) is crucial. IV is often higher in stocks compared to Nifty and Bank Nifty due to the possibility of high momentum movements in individual stocks. Sellers take advantage of this high IV by selling options at inflated premiums.
Let’s take an example of a stock trading at 852. If the stock price increases to 862, it would be the breakeven point for an option buyer. This means the stock would need to increase by 1.2% just to break even. If the stock doesn’t increase sufficiently, the buyer won’t make a profit. In fact, there could be a loss. On the other hand, if the stock experiences a significant increase, the potential for unlimited profits exists.
It’s important to note that when buying options, particularly stock options, many traders focus on the monthly expiration date, such as July. However, it’s essential to be aware of the breakeven point and the fact that sellers are already protected by the high IV. For instance, if the average return of a pharma stock is around 4%, it may not yield substantial profits until the expiry date. If a significant move occurs within 1-2 days, then substantial profits can be made.
To take advantage of short-term big moves, we need to understand two concepts: trigger and trap. A trigger refers to a situation where it becomes difficult for a certain level to be broken, such as Nifty struggling to cross 19000. By analyzing open interest (OI), we can identify significant OI levels where call writers and put writers are present. Between these levels, there is potential for both writers to profit.
The buyer’s probability of making money is generally lower than that of the seller. Buyers may only make money around 33% of the time, while sellers have an intrinsic probability of making money around 67%. However, it is when the sellers lose money that buyers have the potential to make significant profits.
These concepts of trigger and trap, along with understanding the dynamics of implied volatility and the breakeven point, are essential in navigating options trading in stocks. While buying options may seem lucrative, it’s crucial to have a deep understanding of these concepts to make informed trading decisions.
In order to capture big moves in the market, it is crucial to understand the concept of triggers. When a price level, such as 19000 for Nifty, is difficult to break, it can create a trigger point. Sellers, specifically call writers, become cautious when the price approaches this level. They may start unwinding their positions if the price surpasses their break-even point. This unwinding action by sellers can lead to a significant price increase.
Breakout traders and momentum traders take advantage of such situations. Breakout traders wait for the price to go above the trigger level and sustain, indicating a breakout. They then enter the trade, expecting a further upward move. Momentum traders also enter at this point, looking to capture the big move they anticipate.
On the other hand, in the case of a breakdown, when the price drops below a certain level, breakdown traders enter the market. They wait for the price to come down slightly from the breakdown level before initiating their trades. This leads to a downward move, allowing breakdown traders to profit.
To identify these trigger points, one can utilize software tools like Sensibull, which provide insights into open interest (OI) and trigger concepts. By analyzing OI levels and observing the behavior of call writers and put writers, traders can anticipate potential trigger points and make informed trading decisions.
By utilizing software tools like Sensibull, traders can access these indicators and gain valuable insights.
The call difference indicator highlights the percentage difference between the stock price and the strike price of the maximum open interest call option. A positive value indicates that the stock price is close to a significant call option level, suggesting the potential for a big move if the level is breached. For example, if a stock like ITC is trading at 448.6 and the maximum open interest call option is at a strike price of 450, which is only 0.31% away, it indicates the possibility of a significant move if the price breaks above this level.
On the other hand, the trap indicator identifies situations where call writers or put writers may be trapped. These traps can trigger big moves in the stock. Traps occur when sellers who have written call or put options start incurring losses as the price moves against them, leading to unwinding their positions and potentially driving the price further in the anticipated direction.
By analyzing these trigger and trap indicators, traders can anticipate potential price movements and take advantage of profitable opportunities. However, it is important to note that understanding these signals requires a comprehensive understanding of market dynamics and should not be relied upon as the sole basis for trading decisions.
One should also emphasize the importance of considering liquidity while trading in options. Liquidity ensures smoother trade execution and reduces bid-ask spreads. Stocks that are banned in the F&O segment due to liquidity concerns may restrict traders from taking new positions.
By reviewing the historical returns of stocks that triggered trap indicators, traders can gain insights into potential profitable moves. These returns can range from a few percentage points to even double-digit percentages. However, it is crucial to conduct thorough analysis and consider various factors before making trading decisions.
After conducting sector-specific research and identifying stocks with liquidity, it is essential to further analyze the trap indicator and buildup data. The trap indicator helps identify situations where call writers or put writers may be trapped, potentially leading to significant price movements.
By examining the returns associated with the trap indicator, traders can assess the effectiveness of the signal and make informed trading decisions. The stocks where the trap indicator provided favorable results, allowing traders to capture profitable moves.
In addition to the trap indicator, traders can also consider the probable buy and probable sell recommendations provided by analysts. These recommendations can serve as additional insights for trading decisions. However, it’s important to assess the timing of the entry and consider other factors before taking a trade.
The buildup data is another crucial aspect to consider. By searching for the buildup script symbol, traders can access information such as symbol, cycle, and future ROI. The buildup data provides insights into long positions (indicated by green), profit booking (indicated by blue), and other trends.
Understanding the buildup data helps traders assess the sentiment surrounding a stock and make more informed decisions. The colors, such as green, blue, red, and mustard, provide visual cues about the prevailing market sentiment for a particular stock.
To determine the overall trend and sentiment of a stock, traders can utilize the cycle indicator and look at the long and long unwinding cycles within a specific time period. By analyzing the cycle of long positions or long unwinding occurrences over a given timeframe, traders can assess the predominant sentiment for a stock.
For example, if we consider a 20-day lookback period and observe that a stock, such as Bank Nifty, has had at least 10 instances of long positions or long unwinding within that period, it indicates a positive trend. In the case of Bank Nifty, if we see that it has met the criteria of 12 instances out of 20, it suggests an overall positive trend in the stock.
By using these indicators, traders can make data-oriented decisions and take trades based on the observed trends. For instance, if Bank Nifty has shown a positive trend with a majority of green cycles, traders may consider taking positions aligned with this trend. Similarly, for individual stocks like ACC, if there is a put writer’s trap indicated, it suggests a potential sell opportunity.