Those who trade Bank Nifty options understand the importance of volatility and the massive opportunities it creates for option buyers and sellers both. However, today’s 500 points gap down in Bank Nifty spot at 48,057 and 1,100 gap down in Bank Nifty Futures at 47,573, was in stark contrast from other days. Thus in today’s article we shall discuss about this strikingly different behavior in the banking index and also talk about how we can take advantage of the same.
The Narrow Range
To the normal eye, today’s movement in Bank Nifty futures would not seem any different. The index opened at 48098, made a low of 47,905 and then went on to make a high of 48,120. Indeed it is not a big deal, given that the index had merely moved 550 points between the high and the low of the day after a 500 point gap down. Thus a 500 points move is equivalent to a range bound day of trading.
The Backwardation
If you watch closely, Bank Nifty futures opened around 47,573 this morning. Around the same time, the underlying instrument opened 584 points higher, at 48,058. In technical terms, when the spot price of an instrument trades higher than the Futures, the phenomenon is known as Backwardation. As option traders, we must keep in mind, that every time the price of the underlying instrument trades higher than the futures market, it is a screaming opportunity. It is very important to keep in mind that Backwardation is not the same as an inverse drift in the futures instrument. If you observe closely, Bank Nifty futures were not hit with an exorbitant shift in volatility either. The question is why? Is it merely a co-incidence? The answer is NO.
If a backwardation scenario happens with Nifty, it is normal, as it is the benchmark index. However, the same rules do not apply for Bank Nifty. What is most important is, this gap is generally bridged very quickly as Bank Nifty is a volatile instrument. The market makers played it smart today; they ensured that the volatility in Bank Nifty futures remained low. Low volatility helped the market makers maintain the discount gap between the spot and the futures. At the end of the day, the spot closed at 47,773 and futures closed at 47,829.These are the opportunities the market makers are intelligently exploiting at all times.
The Trade
Now let us observe how the market makers made money from the backwardation scenario. Right at the open there was 584 points difference from the low. Thus we can see that the discount gap was not bridged. This is where the market makers stepped in, as the covariance between the Call and Put options gamma and theta was a complete mismatch. We followed their footstep and tracked the 48,000 Call & Put option strikes (also called Pair). The call option was sold around INR 247 and Put option at 199. Although we covered the call at INR 119 and later at 71 approx towards the day end and Puts we covered at 11 AM right when Bank Nifty made Intra Day high.
There is a common belief that selling options, involves huge capital and retail traders cannot take advantage of option selling. Truth be told, selling Bank Nifty options can be sold and covered intraday like the real time example stated above. What is more important, selling Bank Nifty options require approximately INR 22,000 if the position is covered the same day along with complete hedges. (As per Zerodha calculator)
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