Savvy options traders make a killing

Amid market plunge, put options jump 3 times; straddle strategy yields 90% returns

Even as Dalal Street saw erosion of Rs 1.5 lakh crore worth of investor wealth on Thursday, savvy traders laughed all the way to the bank by raking in up to a three-fold return in a single day.

Anticipating that the market would react sharply to the outcome of the US Federal Reserve meeting, several investors, especially foreign institutions and proprietary desks, had built bets on the Nifty through combinations of futures and options contracts

Derivative analysts said some investors used a 'long straddle' strategy, expecting a sharp move in the market on either side. Those with a relatively higher risk appetite had sold Nifty futures or bought Nifty put options. In a long straddle, traders buy a call and a put at the same strike price, allowing for a profit if the index or stock moves in either direction. Traders usually adopt this strategy when they are unsure about market direction but expect a sharp move either way.

Premiums of Nifty put options with a strike price between 5,500 and 5,800 moved up three to four times on Thursday. The straddle has yielded investors a returns of as high as 90 per cent. “Mostly, foreign investors have benefited from on Thursday's move. Certain long-short funds had built decent short positions in the last three to four trading sessions ahead of the (Fed) meet.  They had bought straddle or gone short on index futures,” said Siddharth Bhamre, head, equity derivatives, Angel Broking.

The benchmark Nifty on Thursday fell 2.9 per cent or 166.35 points, to end at 5,655.90 after the Fed signalled a tapering off of its bond buying programme.

“Nifty at the 5,800 straddle was costing Rs 135 yesterday. Traders buying straddles have made money to the extent of Rs 40 (on this much) on the back of the Nifty witnessing a sharp cut of 2.9 per cent today,” said Yogesh Radke, head (quantitative research) at Edelweiss Financial Securities. He said the cost of buying straddle, however, was high on the back of elevated implied volatility.

The volatility index had moved up from 14 per cent to 19 per cent in the past few sessions. Implied volatility had risen in recent sessions as the market was expecting a wild swing due to the Fed meeting, said experts. Typically, implied volatility increases whenever there is an important event lined up which can have a bearing on the market.

“We had seen a rise in implied volatilities in the past couple of days, on the back of uncertainty on the direction of the market ahead of the Reserve Bank meeting and then the (Fed) meeting,” said Radke.

Experts said there were fresh shorts created on the Nifty Index as the open interest had seen a rise on most days this week. Also, foreign investors were net sellers in both the equity and derivatives segments.