Nifty likely to trade range-bound: F&O traders suggest short straddle

Mumbai: Traders anticipating a range-bound Nifty this week could initiate a short straddle — sell a Nifty call and put at 12,100 strike — on options expiring on February 13, said derivatives analysts. The short straddle is sound, given that the Nifty faces maximum resistance at 12,200 and gets strong support at 12,000 this week, they said.

However, if the Nifty moves sharply out of this range upon expiry, option sellers could be exposed to unlimited loss unless they have placed a stop loss. The idea behind shorting a straddle is that when markets are range-bound, option volatility declines with time and this reduces option prices. This, in turn, enables the sellers to pocket much or the entire premia paid by option buyers.

The Nifty closed at 12,098 on Friday. Using Friday closing prices, sale of a 12,100 call fetches the trader Rs 55 a share (75 shares make a lot) and the sale of a 12,100 put gets her Rs 81, or a combined Rs 136 a share. This implies the trader is expecting the Nifty to trade within the 11,964 – 12,236 band. The maximum profit accrues if the index closes at 12,100 this Thursday.

Below or above 12,100, the profit keeps reducing until the upper or lower breakeven points of 12,236 or 11,964; after which unlimited losses begin. If the trader receives premia of Rs 136, she could keep the stop loss at 160-170 levels.

Amit Gupta, derivatives head at ICICI Direct, said he had recommended the short straddle to his clients on the expectation of “falling volatility” amid “range-bound move” of the index.

Indeed, option volatility measured by fear gauge India VIX has fallen from 17.37 a day before the February 1 Union budget to 13.75 on Friday. Over this period, the 12,100 call price fell 57 per cent to Rs 55 a share Friday. Similarly, the 12,100 put plunged 66 per cent to Rs 81, underscoring the profits accrued by option sellers after the fall in options’ implied volatility – a chief determinant of their price.

ICICI Direct’s Gupta expects IVs to come off more this week. Rohit Srivastava, founder, IndiaCharts, added that short straddle was “sound” on a weekly basis as the Nifty could trade range-bound.

Foreign institutional investors (FIIs) have cumulatively net shorted index futures — Nifty and Bank Nifty — to the extent of 1,12,150 contracts, NSE data Friday showed. The buyers of these futures contracts are wealthy clients, DIIs and proprietary brokers. On index calls, FIIs are cumulatively net long 93,592 contracts and on index puts they are net long 1,56,400 contracts. The sellers of index options are clients and prop traders. On stock futures, FIIs are net long 3,70,726 contracts.

Srivastava said whenever FIIs’ index shorting was above 1,00,000 contracts, the markets tended to have bottomed out or were in the process of doing so.