Traders often claim that you can make money buying options and tracking the news at the same time. In today’s article, we shall discuss one parameter which can help retail traders, trade the impact of news, without having any knowledge of the news. We shall also back it with today’s live trade. The function is called Implied Volatility. The important question is why implied volatility? Simply because those who understand the role of implied volatility are champions in trading options.
The Importance Of IV Component
There are several factors that cause option premiums to change. Implied Volatility is the most important amongst them. If you look closely, you will notice, retail traders are mostly focused on news or events while trading, they hardly ever look into the IV. So how can they change this? We all know that there are different factors that are responsible for the movement in options premium. Most of them are successfully computed by experts. However, Implied Volatility is a component, which can be computed only if we know where the market maker is standing between 9:15 am and 3:30 pm. For this reason, IV plays the most crucial role in determining the price of an option.
You shall witness these phenomena on Thursday (RBI MPC). Stay Alert and chant with me – “ PREMIUMS NEVER LIE”
Trade Execution With IV
For ease of understanding, let us consider this week’s example. What we did was simple and can be replicated by retail clients also, once they have a grip on the IV factor. First, we checked the position of the market maker in the morning on 02/02/24 (Friday) and found that they were preparing to sell Bank Nifty.
Then we checked the implied volatility of the option strikes the market maker was focusing on. We found that the IV of those strikes was reflecting unnatural change. This is where things got interesting; we evaluated the IV drift and found that the 46,400 Call and 46,000 Put in the weekly contract was a perfect match. We sold the call option at INR 217 on 02/02 (Friday) which was appropriately hedged and the put option of 46,000 was just added to observe when the IV was conducive. It is important to note that the market maker was also building short positions in Bank Nifty Call at the same time.
From there, Bank Nifty plunged and broke the 46,000 levels and made a low of 45,527. If you look closely, you will notice, when the 46,400 Call made a new low of 21 today, the 46,000 Put surprisingly did not make a new high with underlying making new low than 05/02’s low. Surprising isn’t it? This is the beauty of understanding Implied Volatility. We squared off the position at INR 100 when 46,400 CE witnessed this behavior and the same observation was posted on LinkedIn when 46,000 PE was at INR 600 and it closed at INR 347.