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Charts & Analysis

Option action shifts: Market likely to move fast

Nifty Put options, which were the most heavily traded till the 10th of this month, have slipped; the most action now seems to be in the 4500 and 4600 calls, and some action in the 4500 puts.

Earlier this month, most action was in the puts, mostly 4400 and 4300 levels, and with most negative news out there I figured this was just protection. The law of maximum pain is that no one who tries to insure gets the insurance, so the market stayed choppy but high enough so none of the puts, not even the 4500 puts, were really in the money.

To me it seemed like an opportunity to make money, from a choppy market that doesn’t move. (Note: what follows is a very risky trade, so don’t do this unless you understand what I’m talking about). I traded a short strangle: Wrote a 4450 put and a 4500 call. Premiums when I wrote them (last monday) were 125 on the put and 85 on the call (with the Nifty future being at 4434). The total premium I collected was Rs. 210 per Nifty, which means Rs. 10,500 per lot – each lot is equal to 50 nifty. Margin per lot = Rs. 40,000 approximately.

Current prices for the straddle are around 90 for the put and 73 on the call – so if I square off tomorrow (with the prices staying put) I will pay Rs. 163 – a net profit of Rs. 47 per Nifty = around Rs. 2400 per lot. On an investment of Rs. 40,000 that’s not too bad a return for a week – about 6%. I would hold longer but I’m taking a holiday later this week and don’t want to worry about it when I’m in Goa.

There’s another reason I want to exit – the option action has shifted. Not just have the puts lost interest, there seems to be more interest on the speculatory side – people writing puts and calls and trying to make money from the straddles now. It’s the wrong time to try it – the action has shifted, and I now see a unidirectional move for the remaining part of this month. Only problem: I can’t figure out which direction, yet.

The long month (October options) are seeing huge levels of interest. Again, most of the interest seems to be on the writing straddle/strangle strategies and I’m afraid the maximum pain law is going to hurt them the most. One “black swan” event will wipe them out – and it seems to be the right time for such an event, since money is being bet on the fact that the market WILL NOT MOVE. Ever so often, that assumption does not hold.