Devils advocate - Trading strategies for May 16 2014 Lok Sabha election results

May 16, 2014 is a crucial day for Indians and our stock market. Since months retail traders, HNI, FII and other institutional traders & investors are placing their bets based on the most likely outcome of 2014 Lok Sabha election results as per their analysis. Some of them are playing the market purely as a speculative game, some are hedging their positions and some are picking up specific stocks based on a probability of a particular party coming to power

In 2004 and 2009 on the election result day market has given very volatile moves in both the direction. Based on these previous reaction of Indian Stock Market to election results, we see that India VIX has considerably gone up. Previous week Indian market was listless for most part of the week, but on Friday there was more than 3% move on Nifty with high volumes. There were rumors that exit poll results are leaked and this buying continued on Monday (12th May) also. Today i.e 12th May exit poll results are out for 2014 Indian Lok Sabha elections and most of them pointing towards various scenarios of NDA coming to power. Some predict that 272 mark would be easily met and some predict that they would come within striking distance of crucial 272 mark. All traders need to note that exit polls are not accurate and many time they have not predicted the results accurately especially when there are more than 3 strong parties fighting for seats like you see in UP. Whatever the personal preference of a trader that shouldn't be basis of taking trading positions especially naked positions without hedging and betting on a particular party coming to power.

Looking at the recent up moves in the Indian stock market, looks like traders are positioning their bet thinking that NDA would come to power. Many traders are buying both far out of the money calls and puts expecting a volatile move on 16th May or after exit poll results would be out.

Let us just look into a very simple but popular option strategy (Just for analysis):

Buy out of the money 7200 call : Rs 198

Buy out of the money 6800 put: Rs 165

Currently Nifty trading at around 7000 points. For traders to make money from above strategy market need to move 200 + 198 + 165 , which is around 8% move from current level of Nifty, in either direction from today until close.

• If on 16th May actual poll results are not as per expectations and NDA struggle to come to power then there is a high probability of a very significant down move and the above strategy can be profitable.
• If BJP alone gets 272 seats then market might react very positively
• Poll results show that NDA may not get majority but can form government with help of other parties or NDA gaining simple majority. Here we can’t assume that market would surely go up significantly and traders make money.
• There are 2 factors here, market has already run up and profit booking can come to play this is typical “Buy on rumor and sell on news” .Election results event may not be immune to it.
• Also during previous two election results days i.e 2004 and 2009 market has given high percentage moves and many market players are trading based on this. When something become too obvious market might surprise us. Even if market doesn’t get into negative territory but moves up just couple of percentages the above option strategy can be loss making due to high premiums involved

Note: There are numerous other trading strategies traders can use here like buying only calls or puts, selling options, using futures, complex option strategies like butterfly, iron condor etc. These are beyond scope of this article, we have used the above option strategy (buying out of the money call and put) to explain the likely outcomes.

Now trader need to get onto drawing board and think about all likely scenarios that might happen on 16th May. Playing a devil’s advocate here. One of the scenario might be that due to exit poll market might factor in major part of the move before 16th May and its always better to book partial profits if sitting on profit on 15th May itself. Other scenario is that If there is a move but not significant enough on May 16 then expensive option premiums may come down.

As a traders we need to make sure that our personal election result preferences doesn’t reflect on our trading strategies. We shouldn't place all of our bets on single direction without stop loss during such binary events. Most important factor is use exit poll as just one of the inputs and not the only input as such polls are not accurate always.