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CM Strategy

Optionalysis: When Buying Straddles Fail – TCS Fell 4% But Option Sellers Still Took Home The Moolah

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TCS fell today after the market didn’t like its results. Oh, and the market fell too, but TCS fell 4%. It  has fallen from 2583 to 2474, a fall of Rs. 109 in a day.

Would you have made enormous money if you bought options the day earlier? Obviously if you bought puts you would have made some money, going by today’s option chain:

Option Chain

The puts (on the right) have gone up, but you notice, not substantially! The 2500 put, which you think should have made enormous money, has only gone up Rs. 9.5 to Rs. 52. Which is not the multiple you expect to see, since options are supposed to double!

The problem: TCS Option Implied Volatilities (IVs) dropped big time. See them fall from the 35 levels down to below 25!

TCS Before

 

TCS After

(The Implied Volatility of an option is how you describe what people are paying for the expected jiggles in a stock price. At Rs. 2584, the 2600 call option expiring on 30 April will have to be priced based on how many days are left to expiry, how much the market expects the stock to move in that time – measured as the IV, and other factors like how much the risk free market interest rate is.

Typically, as we get closer to the expiry date, the number of days remaining falls, so options lose value; this is called time decay. But in this case, we see a fall in premium not just due to the time decay but also due to the drop in IV.

Why does IV drop? Because the “risk” of the event – the TCS Results – is over. There is less uncertainty – you know now what the company has done. So the expected jiggle will be smaller. )

Option Strategies Fail on the Buy Side

Regardless of the 4% move, a purchase of the put and the call would have resulted in tears, for the most part. We know that straddles involve buying a call and put at the same price, and strangles are the same if bought at different strikes (lower strike call, higher strike put). Here’s how TCS strategies would have done:

TCS Option Chain

As you can see, the only one that “worked” for buyers is the 2700 straddle. At the price of 2583 that’s hardly a straddle, though, as a straddle is supposed to be close to the stock price. At 2700 that is just like buying a deep in the money put (most of the premium would be for the put option anyhow).

Straddle sellers – those who wrote the options instead of buying them – will be laughing all the way to the bank. Even a 2600 straddle lost 18 rupees. For, say, 500 TCS, that is a return of Rs. 9,000 for the option seller, for an investment of about Rs. 5 lakh, even when the stock moved 4%!

Even deep out of the money strangles, like the 2400-2800 strangle lost money for buyers.And made a reasonable amount of money for sellers. Earlier in the day, the stock hadn’t even moved that much and the profits were even higher for option sellers.

Infy Results?

Going by this kind of chart, it would make sense to trade Infy results similarly, one supposes. That is, don’t buy options, write them instead? 

Infy options currently trade at 35+ on the IV, which makes them attractive enough for a 4-5% move expectation. Infy has moved more in the past on results days, but that’s the risk one has to take. This time it’s not even the first bird on the results table!

And if options go up in IV even more before the day, they might just turn juicy enough to short; however remember the risk is huge if the company does things that are unimaginable.

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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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