top of page

PREMIUMS NEVER LIE!

In the world of Matrix, as most of us has seen in the movie, numbers do not go wrong as they form the very basis of your existence. Similarly, premiums form the same base in derivatives market. Let's see how..




India’s Most Volatile Bank Nifty futures triggered a massive upswing in last three trading session. The index plunged 2,478 points in the last 5 trading sessions before the reversal and registered a low of 46,579 on 19th April. It’s good to see Bank Nifty fall 2,478 points and then bounce back sharply by 1,723 points in a week. Wouldn’t it be interesting if you knew when the index will fall and at what point will it turn around? This week’s expiry bounce back triggered one such contrarian swing opportunity. However, the question is, is it possible to first catch the fall of 2,478 points and then enter today’s upswing of 1,723 points? The answer is a Big YES. Let’s discuss.


Options Counterpoise To Catch Big Moves


In simple words, options counterpoise is a mathematical calculation used by institutional traders during live market hours. This method accurately captures options inefficiencies for specific option strikes at time “t”. The biggest advantage of options counterpoise is it pinpoints the trend of a derivatives contract accurately. Surprising as it might sound, this derivation of the BSM differential equation is completely risk free.


How Institutional Traders Use This Method


The institutional traders think like bookies. Let us assume two horse’s “A” and “B”. in a race at time “t”. There must be only two possibilities here. Either “A” will win the race or “B” (Stale mate is not an option). Let us assume, that the market maker has all the inside news. He knows that horse “A” has 80% probability of winning and people are willing to pay INR 500. On the other hand, the odds of “B” winning, is 20%. So, people are willing to pay just INR 100 for. Based on inside information, the market maker sets the odds at 1:4. Let’s keep in mind that this is exactly the case of news-based trading.


Case 1


Horse “A” wins

The bookie must pay back INR 500, plus INR 125, which is a total of Rs625. However, we know that the bookie had collected INR 600 in the beginning (INR 500+INR100). So his net P/L is loss of INR 25 (600-625). Let us keep in mind that he had all the news and still lost money.


Case 2

Horse “B” wins

The bookie must pay back INR 100, plus INR 400, which is a total of INR 500. However, we know that the bookie had collected INR 600 (INR 500+INR 100). So, his net P/L is a profit of INR100 (600-500).


We learned that if the market maker trades based on news, they can lose money, even if they have inside information. So, it is fair to conclude that the institutional traders avoid news and use options counterpoise. Thus, they make money consistently, as this method is risk free.

 

Catching the Upswing


In the past 5 trading sessions before the reversal on 19th April, Bank Nifty fell 2,478 points. 19th April was the first time that the institutional traders started wrapping up their shorts. Based on the institutional positions and the counterpoise range, we wrapped up our shorts also and went all out for the upswing. So, we followed the footsteps of the market maker and had sold 47,100 CE at INR 484 on 18th April and squared off the strike when market opened gap down on 19th April at INR 236, thus realising 50% premium. Thereafter Bank Nifty witnessed a wild swing and registered a high of 47,668. On Monday, we created spreads Intra-day by Selling 47,800 PE at INR 228 and 48,000 PE at INR 430. Both the put strikes were squared off intraday at INR 157 and INR 275 respectively generating a stunning return of Intra-Day.


FYI- We use very strong hedges while trading.

This article has been used before. This time it has been used to explain in a different example.





 

 

20 views0 comments

Recent Posts

See All

Comments


bottom of page