India’s Most Volatile Index Bank Nifty Future registered a high of 41,792 (spot level) yesterday. Today was a good day to understand how ratio trader’s function. While most market participants were anticipating a buy breakout this Friday (3rd February, 2023). The institutional traders took advantage of the situation and made a smart move. They forced the index to remain inside a range of 1200 points after it touched 40,600 levels. The question is how did they do it?
The Institutional Spread
You’ll notice, Bank Nifty registered a flat opening today around 41,530. The index then registered a high of 41,791. Thereafter Bank Nifty slipped into a narrow curvature. The question you want to ask is, “Why Bank Nifty slipped into a range if the Friday’s close was at day’s high”? Always remember, unless the Vega expansion in Bank Nifty meets the required criteria, the market maker will use these pop-up moves going forward to adjust the squeeze the option premium in their favor. This week was one such week.
When To Create Spreads
So how do institutional traders understand that they should create spreads? The first thing we must understand is, they create spreads either to eat up time decay or drift along with the shift in market volatility. So, the market makers track the options Vega very closely. We all know that both time and volatility are essential components for the option buyer to generate profits. And that is exactly what they try to offset. This phenomenon is very similar to a time stochastic process where the value of the option premium melts away causing damage to the option buyer’s position. Unless any surprise event is triggered, the market maker has enough room to adjust the position in his favor as time continues to slip away. This is exactly why you’ll notice that the option you buy, sometimes will not generate returns despite trading on the right side of the trend.
Live Example
As shared in our recent newsletter, Terminal Volatility gave us two strikes as of Friday close(3rd February, 2023). There are 5 trading sessions in a week starting from Friday. Everyday has its own unique calculations and triggers. 42,000 CE and 41,300 PE were the range we mentioned in our newsletter and said that collectively if both goes below INR 282(CE+PE), market might remain in the same range. This trade usually triggers on Tuesday as theta acceleration speeds up post Tuesday 2nd half. Accordingly, 42,000 CE and 41,300 PE were sold and were hedged by buying far OTM strikes. Well, guess what? Those above strikes closed at 0. We covered the entire position when CE+PE were at INR 15. Beautiful trades come across if you talk to premium on a regular basis.