 "Option selling in a low-volatility phase")
The December settlement went through with little excitement. The market may be in a phase of low volatility and moderate volume. Although the trend seems up, many key players are in pause mode. Foreign institutional investors (FIIs), in particular, could be reviewing their 2014 allocations.
One way to exploit a low volatility phase is to sell options at a distance from money. Option selling is normally dangerous. The theoretical losses can be infinite. However, if one is to sell options, it is better done in a low volatility phase. First, low volatility makes it more likely that far-from-money options will not be stuck. Second, if the low volatility lasts a few sessions, premiums reduce. This allows a quick square-off.
The switchover to a new settlement is an ideal period for an option seller. Mid-month option chains are high premium until they become near-month options, whereupon premium tends to drop.
Let's take a quick look at technical details. The trader who wants to sell options has to judge likely volatility in the relevant time period. He also has to set a stop-loss, where he will reverse the trade and take a loss.
One quick, dirty way to judge likely volatility expectations is to look at close-to-money strangles and straddles. The Nifty closed out the settlement session at 6,278 (spot price). The January futures index was at 6,343. The futures premium over spot is likely to decline to about 40-50 in a few sessions but that's less relevant.
The premiums of strangles of the spot – that is a 6,200p (68) and a 6,300c (133) come to about 201. Strangles of the January future – that is 6,300p (90) and 6,400c (84) come to about 174. Breakeven for the spot strangle comes at around 6,000 and 6,500, while the futures strangle has breakevens at 6,125, 6,575.
The market doesn't expect moves beyond 6,000 or 6,600. The 6,600c is available at 24, while the 6,500c is available at 48. The 6,000p is at 21 while the 6,100p is at 35. Selling closer to money carries greater potential reward and greater risks. Any Nifty option short position requires around Rs 25,000 margin per lot (50 units).
This trade would buyback around Monday (Dec 30) or Tuesday (Dec 31). A premium decline of 35 per cent or so can be expected if the Nifty stays range-bound. The trades can be stop-lossed at a premium increase of about 20 per cent. Are option sales worth it in the circumstances? Probably not. The return on margin deployed is low. Is it worth looking at? Certainly. Once in a while, it will be a very good trade.
One way to exploit a low volatility phase is to sell options at a distance from money. Option selling is normally dangerous. The theoretical losses can be infinite. However, if one is to sell options, it is better done in a low volatility phase. First, low volatility makes it more likely that far-from-money options will not be stuck. Second, if the low volatility lasts a few sessions, premiums reduce. This allows a quick square-off.
The switchover to a new settlement is an ideal period for an option seller. Mid-month option chains are high premium until they become near-month options, whereupon premium tends to drop.
Let's take a quick look at technical details. The trader who wants to sell options has to judge likely volatility in the relevant time period. He also has to set a stop-loss, where he will reverse the trade and take a loss.
One quick, dirty way to judge likely volatility expectations is to look at close-to-money strangles and straddles. The Nifty closed out the settlement session at 6,278 (spot price). The January futures index was at 6,343. The futures premium over spot is likely to decline to about 40-50 in a few sessions but that's less relevant.
The premiums of strangles of the spot – that is a 6,200p (68) and a 6,300c (133) come to about 201. Strangles of the January future – that is 6,300p (90) and 6,400c (84) come to about 174. Breakeven for the spot strangle comes at around 6,000 and 6,500, while the futures strangle has breakevens at 6,125, 6,575.
The market doesn't expect moves beyond 6,000 or 6,600. The 6,600c is available at 24, while the 6,500c is available at 48. The 6,000p is at 21 while the 6,100p is at 35. Selling closer to money carries greater potential reward and greater risks. Any Nifty option short position requires around Rs 25,000 margin per lot (50 units).
This trade would buyback around Monday (Dec 30) or Tuesday (Dec 31). A premium decline of 35 per cent or so can be expected if the Nifty stays range-bound. The trades can be stop-lossed at a premium increase of about 20 per cent. Are option sales worth it in the circumstances? Probably not. The return on margin deployed is low. Is it worth looking at? Certainly. Once in a while, it will be a very good trade.
The author is a technical and equity analyst