Traders are taking a cautious call in the stock markets ahead of the Union Budget, as volatility in the derivatives segment is at its highest in the past two years. The implied volatility (IV), which is the estimated price of an underlying security, rose to 34 on Wednesday.
Usually, it is around 20 and after every sharp recovery in the markets, falls further. Even while the benchmark equity index, the S&P CNX Nifty of the National Stock Exchange (NSE), has staged a strong recovery from its recent lows of 5,200 to around 5,470 in a month’s time, the IV is at its peak, confusing traders.
“Despite a strong bounce-back in February, traders are buying cover on both the long and the short side,” said Siddharth Bhamre, head of derivatives at Angel Broking.
“A normal trading strategy that people are adopting ahead of the Budget is buying a straddle (call and put option at similar strike price) for the March series to remain market-neutral and take advantage of volatility,” said Shashank Mehta, derivatives strategist at Nirmal Bang Securities.
After the impasse in Parliament during the winter session, government policies in the Budget on February 28 will determine the mid-term direction of the markets. Motilal Oswal, chairman and managing director of Motilal Oswal Financial Services, said: “There is a very strong possibility that the Budget could be a game-changer as far as the direction of the stock markets is concerned. The market has a very strong inertia on the downside right now. If there is one event that can change that, it is the Budget.”
Hedging bets
Among the strategies traders are using are buying synthetic calls and delta hedging. “Domestic institutional investors are doing delta-neutral trades to take advantage of either-side swings,” said Mehta. A synthetic call mimics a pay off of a call option, whereby traders purchase an underlying asset and hedge risk by buying a put option. Buying a call option means taking a bullish call on the market, whereas buying put means going short.
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Mehta said, “Traders are buying a futures contract on the long side of the markets and capping the downside risk by buying a put option. The net effect of this is of buying a call option.”
Adding: “Synthetic call positions are seen for the March expiry, as the theta (daily decay in the option value) in the current expiry is very high. Huge build-up of open interest is seen for the 5,400 put option for the March series.
“For any trade, at the end of the day, the delta has to be zero. If traders buy a call, it is 50 delta plus, and if they buy a put, it is 50 delta minus, hence the delta is zero and the position is market-neutral, which means they are not either bullish or bearish.”