In today’s article, we shall discuss why Bank Nifty Futures failed to capitalize on the sharp upside rally of 200 points triggered in the first 30 minutes of trade. We shall also showcase how mispricing in Call options played a vital role in the loss of bullish momentum around the 48,200 zones. At first, we shall observe the 47,800 Call option for the 3rd January 2024 contract because that is where the primary action took place today and the FII’s capitalized on the loophole.
Photo Source - New York Times magazine
The Fair Value
Step one is understanding what the market maker is trying to do, step two is about calculating the fair value of an option strike based on the contract they are trading. This is why it is important to ask why did we target the Call option in the morning and not the Put? This is because, when we used the 3D Delta software yesterday, we found that the market makers were building shorts since 28th Dec 2023, which they hurriedly covered by the end of the day. So we were eagerly expecting a positive opening today. This is where the scenario got interesting; Bank Nifty opened the gap up today.
The Gap up Opening
Today’s flat opening at 48,199 was very significant. Remember that the market had closed at 48,064 yesterday (Friday). This is what led us to look into the Call strike in the morning. The next question is why did we choose the 47,800 Call? We chose the 47,800 Call because it was the strike which was closest to the fair value and it was a fantastic opportunity from the risk management metric. Here you must keep in mind that timing is very important as fair value also adjusts alongside the theta decay during live trading hours.
Using Option Mispricing
After the market opened at 9:15 am, the undervaluation in the 47,800 Call option was very clear. Just observe Bank Nifty on 29th Dec-30th Dec and 1st Jan, futures made new high and Calls were nowhere to new highs. Only to capture these fast opportunities is to have a good system in place in real-time because the FII execution is fast and furious. If you look closely, you’ll notice, the opening price of 47,800 calls option was INR 497. The call strike opened at 497 and hit INR 509 in under 40 seconds. We entered the Sell call option at INR 238 and the market started its downtrend. Appropriate hedges were used while taking this trade. 47,800 PE was to be watched closely for entering in a call sell trade. At the price of 108 (LTP), Sellers had to cover their positions which happens to be a Vega neutral zone. Post crossing 108, we never got a single minute closing below 108 for the rest of the trading session, that’s how we were sure about the down move.
Since the upside rally was built on an undervalued call option, it was very important to understand that the upside rally in Bank Nifty would also last till the mispricing opportunity prevailed zone. Around INR 243 the market makers began squaring off long positions. The process took the whole day. Throughout the rest of the day, profit booking was observed and Bank Nifty continued to slip downwards towards the 47,690 zones. The 47,800 Call option settled at INR 114, while Bank Nifty closed at 47,762. This is what makes options trading worth the patience and time.