Indian stock markets had not received a big correction in the last several years. This time the market’s major index has fallen by 15-20 per cent from peak. This is a good chance of shopping in the market, but it offers a challenge. The challenge is that if you are shopping then when should you stop your shopping. I believe that we can take help of volatility to understand the initial signs. But, before doing so, it would be good to revise the basic characteristics of equity and volatility.
For volatility, we are talking about the completion of the premium of the options. This is a figure that is calculated with the help of mathematics formula. No one needs to do this calculation because many options analytics appliances already have this information available. This information is also available on the exchanges website, where these options are traded.
Employees Voltylity (IV) have two basic features,
1. Its nature is to live in limited scope
2. It has an opposite relationship with underlining stock or index
The first is a completely strotforward observation. There is some logic behind the second feature. The logic is that if a stock or index falls rapidly with its momentum or volatility, then the speed of the same stock or index climb will be dull in the event of fast. The reason behind this is that the constructive move always takes time, but the pace of falling of something is always faster. This is the nature of an asset class.
We get a trading system when we see the first and second feature together. Now whenever IV is at a lower point, we expect to go on top of it. The price of the underling can be expected to go down when going over IV. We use this for the observation of the IV climbing. With this, we can put stoploss in bye trade.
I can explain it with the example of the Nifty Index. However, it can be used with stocks with its respective IV chart. We can use India VIX as proxy IV for Nifty. It is available as charts on many websites.
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1. Mark the Lost Point for the last six months.
2. Lost Point + India was cautious about 10 percent of VIX.
3. Wait for India VIX’s Step 2 Day alert to come closer to Incident Day.
This is the time to act. If you do not want to exit, keep your stoploss low. You can keep it so low as much as possible.