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Alternative and Cheap Strategy of Investing in Blue Chips with Potential

a cheap way of investing in blue chips
Alternative and Cheap Strategy of Investing in Blue Chips with Potential
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I’m sure that many of you want to invest in a blue chip that seems to have a lot of potential in the short-medium term, but lack the resources.

Most blue chips are priced sky high and you can hold only a few in your DP account because of the high value investment required.

For example, if you figure that Nestle has potential to run up substantially in the medium term, and want to invest in it, then you have to  invest Rs 1,05,000 to buy just 10 shares. The psychology of an investor is such that he does not feel happy investing a large sum in a very few shares Рmost investors prefers quantity over quality.

So, the investor ditches the blue chip and moves on to low priced B group stocks, thereby missing out on a chance to invest in a blue chip.

This guide is intended to help small investors buy a substantial quantity of any blue chip by investing a few thousands. Remember this guide is only for investment in blue chips that are traded in FnO and is suitable for short-medium term investment.

STEP 1: PICK THE STOCK

Picking the stock depends on your trading strategy. Some use screeners, some watch TV channels (though not recommended for stock picks), some watch Open Interest data or economy- or company-related news, etc.

For this post, we have picked HDFC, CMP 1984 as on 20-3-19 close.

STEP 2: DETERMINE THE HOLDING PERIOD

Determine for how long you want to hold the stock. This depends on your trading temperament. Short termers typically hold 3-6 months, medium termers for 12-18 months.

Know that this strategy is not suitable for long term investing.

STEP 3: SET EXPECTATIONS

When you invest in any stock, you need to set targets. So, how much do you expect your stock to appreciate? Let’s say that for this post, we have set a target of 25% appreciation in 3-4 months. This means we are expecting HDFC to touch 2500 in 4 months.

STEP 3: COMPARE EXPECTATIONS WITH VOLATILITY

The rate of interest per month in private lending is at least 1.5% per month. In extreme cases it can exceed 2%. Let us say that if you were to borrow, you would have to pay 2% per month.

Now check the volatility of our pick – HDFC:

— Google “HDFC Volatility” (without the quotes)

— Your first result will be of TopStockResearch.com. Check the volatility.

how to check the volatility of a NSE stock

For HDFC, the minimum volatility percentage is 1.67% per month and the maximum is 10.17% per year.

Based on historical trends, for our trade, HDFC can fluctuate by a maximum of 10% within a year (so for four months too it can fluctuate 10% either way).

But we are expecting it to move 25%.

This is an anomaly and if we are not careful, we can make a loss.

So the first thing we should know is:

If volatility is higher than our expectations, then we have a 50+% chance of succeeding.

But if volatility  is lower than our expectations, then it can result in a loss. In such cases, we need to check the charts.

STEP 4: CHECK THE TREND ON THE CHARTS


how to identify blue chips

HDFC seems to be in an uptrend (on daily and monthly charts) as per a trendline.

If you want to learn how to draw a trendline, read this post.

Plus we have come to some kind of conclusion that the stock will appreciate 25% in 4 months. Of course, this expectation needs to be backed by solid reasons and data – for example, liquidity norms relaxed for housing companies by RBI can benefit HDFC, HDFC is one of the leaders in housing finance and has solid parentage, etc.

At this stage we must be reasonably certain of an upward price movement before proceeding to the next step.

STEP 4: CHECK THE PREMIUM OF AN ALMOST AT-THE-MONEY CALL OPTION FOR THE NEXT EXPIRY

In the case of HDFC, the 2000CE for APRIL EXPIRY IS priced at 53 bucks.

Now, 53 bucks is about 2.67% (53/1984).

Remember above that we have assumed that we will end up paying 2% interest per month if we were to borrow from a private lender.

We also can assume that HDFC can fluctuate 3%-5% (or even 10% – the full range of its annual volatility) given the market conditions as on 21-3-19 (Fed paused rate hike, markets in bull grip, gush of liquidity for HFCs, bullish trend on charts, solid company, etc.)

Therefore, based on reasonable assumptions, economic news, global markets and our expectations, we can assume that the premium of Rs 53 on the HDFC 2000CE is worth investing in.

If the premium seems overpriced – DO NOT ENTER INTO THE TRADE.

STEP 5: DEALING WITH LOSSES AND CARRYING OVER

Even though you are reasonably sure of HDFC price appreciating, you must also be prepared for a fall in its price.

Therefore, stop losses are essential and this is where your Risk:Reward ratio comes into play.

Let us say that you are 66% sure of HDFC appreciating and you figure that in April it should do 2075 at least.

Your typical Risk-Reward is 1:2.

So, this implies that you are expecting a 75 buck jump and therefore should budget for a 37.5 buck fall in its price. If it falls by 37.50 bucks, you should square up your 2000CE.

But that doesn’t mean that you should give up on your bullish views.

As HDFC begins to turn around after a fall, and if the markets are in good or steady health, you must re enter at a lower strike price. Of course, you should apply all the assumptions above (volatility, market conditions, global markets, etc.)

STEP 6: HOW THIS STRATEGY HELPS

Think about it: If we are bullish on HDFC today and wanted to buy 500 shares, we would have to shell out 10 LAKHS. But with this options strategy, we paid only Rs 26,500 (1 lot of HDFC = 500 shares).

Even if the HDFC price were to fall after our buying the stock in the spot market, we would have incurred similar losses just like wwe would have incurred were we holding the CE.

Suggestion

The advice to you is to try out this strategy on paper and become more comfortable before entering an actual trade.

This is all there is to it – it’s very simple and effective when you think about it. Good luck.

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