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Optionalysis: Nifty Looks Poised For A Trend Change

Optionalysis: Nifty Looks Poised For A Trend Change

This is a Capital Mind Premium subscriber post, sent on 30 May 2014.

Be Careful. Option trading is largely focussed on the Nifty. The Nifty has suddenly turned volatile, from +75 points in the morning to about -30 points right now. There seems to be a break down in the short term, with the 6700 level a key support that is being tested. (In the hourly chart below)

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This seems to be because Narendra Modi has received an Election Commission notice of a code violation which could lead to imprisonment.

Optionalysis: Nifty Looks Poised For A Trend Change

With a negative sentiment in RSI (which we spoke in Learn TA), and a negative MACD crossover, we also have the the fact that a key level of 6700 (on the future) is being tested.

At this point we check two things. One level higher is the dailies, which again shows that the current move has broken through a trendline. However, it does need to break below the 6700 to really be a break down. Strong support at the 6400 level exists.

Optionalysis: Nifty Looks Poised For A Trend Change

The other is the implied vol check on options.

Optionalysis: Nifty Looks Poised For A Trend Change

Calls are trading at a higher relative implied volatility than puts. and for some reason the implied vols for the 6900 call is even lower than that of the 6700 call.

This makes it better for us to go short calls, or long puts. The absolute levels of implied volatility are near 30, which is beneficial for a short option position (which gains on time value being lost).

We are avoiding trading the future directly at the moment.

Given the upward resistance of 6900 (that’s where the future turned back) we would consider writing a call spread at 6700-6900 for (235 minus 149). This would make sense if by 3:30 the Nifty future closes below the 6700 level.

The other option is to buy a 6700 put (at Rs. 220) and sell the 6400 put (at 110). This is a debit spread so the risk is lower, but the options will lose time value faster.

We should prefer the credit call spread because time value will be lost faster. Implied volatilities are at high levels. Remember, tomorrow (May 1) is a holiday and we can “eat the premium”.

However, the negative case is that the Election Commission might easily step off from their position and the markets will bounce back on Friday. In fact, given that we’ve have a lousy week, and Friday’s the last day of the week, there might be a “profit booking” rally just to close things out.

The risky bet is to do the credit call spread now. (If the Nifty Future breaks down below 6700) If the Nifty continues to break down on Friday, we should book that profit and trade down with a future that has the maximum reward, while writing the 6400 put.

A less risky one is to wait till Friday and then buy the 6700 call (naked) if the markets bounce back up, or to do the debit put spread above if the market breaks further down. 6700 is the key level.

(We’ll decide what to do in a few minutes, but this is a heads up post)

Optionalysis: Nifty Looks Poised For A Trend Change

Disclaimer

Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.

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  • DJ says:

    Amazing pop in the VIX today. Either someone knows about some upcoming news over the weekend, or its just high interest, with potentially more to come in the days until the election results day. Would a straddle held over the last two weeks done well?

    • Two weeks ago, on April 17, a May 6800 straddle was at 314+266 = 580. Today it’s 283+211=495. So no, it would not have worked well 🙁
      In fact from April 1 when the same straddle was around Rs. 500 (24% imp vols), it would still have been loss making. But hten, the Nifty hasn’t moved much. Which is the cause for it to have lost money!