Current volatility provides arbitrage opportunities to investors.
Rising market volatility has spurred a threefold increase in the monthly average turnover in National Stock Exchange (NSE) index options in the last one year, as perennial traders adopt complex strategies.
The index options’ average monthly turnover has risen to Rs 99,047 crore in January, as against Rs 36,624 crore seen in the same month last year, accounting for 70 per cent of the total derivatives volume. On the other hand, average monthly volume in index futures has risen only marginally to Rs 15,728 crore from Rs 19,224 crore a year ago, contributing only 13 per cent to the derivatives turnover. The turnover in the NSE cash market has also declined to Rs 13,312 crore from Rs 17,793 crore in January 2010.
| MIXED BAG AVERAGE MONTHLY TURNOVER (Rs CRORE) | |||
| Month | NSE Index Future | NSE Index Options | NSE Cash |
| Jan ‘10 | 15,728.90 | 36,624.20 | 17,793.00 |
| Feb ‘10 | 16,343.50 | 42,361.80 | 12,250.90 |
| Mar ‘10 | 12,774.60 | 40,150.80 | 13,599.30 |
| Apr ‘10 | 13,978.60 | 45,273.60 | 13,802.80 |
| May ‘10 | 18,838.70 | 57,974.20 | 12,905.90 |
| Jun ‘10 | 16,921.20 | 53,179.20 | 12,984.90 |
| Jul ‘10 | 13,155.60 | 47,425.20 | 12,655.10 |
| Aug ‘10 | 13,596.80 | 52,612.10 | 14,140.60 |
| Sept ‘10 | 18,279.60 | 80,403.30 | 15,688.60 |
| Oct ‘10 | 19,164.60 | 81,214.90 | 17,134.30 |
| Nov ‘10 | 20,228.10 | 90,616.40 | 17,309.70 |
| Dec ‘10 | 14,672.40 | 69,058.20 | 13,406.50 |
| Jan ‘11* | 19,224.70 | 99,046.70 | 13,311.80 |
| * Till January 28 Compiled by BS Research Bureau | |||
Shailesh Kadam, derivative analyst at PINC Research, said, “Whenever the markets correct, volatility increases and the underlying premium for put options rises. This resulted in a threefold spike in the index options activity between January 2010 and January 2011.”
The Volatility Index has been hovering in a broad range of 16-28 for the past one year. Traders are looking at complex ways to hedge their exposure, as no frills trading (going long on index and stock futures, a popular strategy in 2009) may not work in a bear market, says Siddharth Bhamre, head of equity derivatives at Angel Broking.
Kadam said, “Foreign institutional investors and traders have increased positions in long options and are buying straddle (buy call and put at a similar strike price) and strangle (buy call and put at a different strike price) because they believe the markets can swing in either direction.” The current scenario is also providing ample arbitrage opportunities to investors. Institutional investors were going long on equities, or short on futures, and keep adjusting their positions by buying and selling options, said T S Harihar, senior vice-president, ICICI Securities.
Deven R Choksey, managing director, KR Securities, reckoned, “Traders with naked positions in futures have become quite active in options.” For instance, if a trader has bought the 5,500 Nifty future, he also buys a 5,400 put option to protect losses in case the market falls suddenly. Besides arbitrage trading, fund managers have also resorted to complex strategies like delta neutral. Delta is the ratio comparing the change in the price of the underlying asset to the change in the price of derivatives. In this strategy, the deltas are balanced out to bring the net change in the position to zero.
Kadam said, “Fund managers have adopted a delta neutral strategy to maintain their portfolio, as unwinding each and every strategy will have an impact cost. Delta is the risk. Hence, in order to safeguard losses, they buy and sell options.”
Bhamre said, “Volumes may have risen because the securities transaction tax is charged only on the option premium and not on the contract value. Hence, in terms of absolute value, it is economical for traders to trade in options than in futures.”
Since a lot of retail and high net worth traders have shifted from futures to options, Harihar said traders should be cautions, as option writers faced unlimited risk and might get wiped out if there was an unexpected movement in the markets.
