Excessive Volatility Despite Low Vix?

There has been an utmost confusion between the market participants as to what should we do when VIX is low? They do not get to receive big premiums and traditional strategies turn out to be a failure. In option world, this situation usually takes 80% of year’s trading days. Hence, a very pertinent question arises, HOW DO WE PIVOT? And the answer always hovers around you and one just has to ask the real question to the market. It’s always been PREMIUMS! Let’s understand a technique which proves to be an alpha tool used by High Frequency Traders (HFT) - SCALPING

Picture Source - Bloomberg Article

What Is Scalping?

Scalping is an intraday trading technique that is built to achieve results by quickly swinging in an out of trades. In scalping, the cumulative returns of all the trades take advantage of the erratic moves in the market.

The Overvalued Call Options

To understand, this week’s volatile move, we need to look at the valuation of the 44,000 Call option of the 17th August 2023. On 14th August, Bank Nifty opened with a gap down of 103 and post that it recovered entirely from a low of 43,776 and made a high of 44,212. This sudden recovery did two things.

1) Made Put slightly undervalued

2) Made Calls highly overvalued.

Although Bank Nifty made a high of 44,212, what was observed was that call sellers, also ITM call sellers weren’t affected that much. (Here we are talking about smart money since they sold calls at the open). Even as day high was crossed, these sellers were somehow confident of the fact that they need to keep the Bank Nifty under 44,000.

The recovery of 432 points from the low of 43,776, led to Puts making new low and calls not even going above day’s open price. This created an opportunity for scalping as mispricing occurred.

Live Example

Around 14th August’s high, the gamma and the theta covariance factor of the 44,000 Call were exorbitantly high. This was a big opportunity for scalpers. Since it was a Friday of the August weekly contract coupled with holiday on occasion of Independence Day, the same strike was sold by scalpers. Three factors that supported the selling were the massive expansion in the 44,000 call option premium above its fair value, India VIX below 14 and the acceleration in theta decay. 44,000 CE was sold at an average of 179 and later covered at 70. This sold strike was carried forward as we calculated where smart money would cover it.