India’s most volatile Index, Bank Nifty futures triggered a sharp upswing of 700 points today. Today’s up-move was a magnificent example of option mispricing. Although news headlines in the morning screamed “$3.6 billion bonanza into Indian Equity markets, No more Fed rate hikes, State elections exit polls discounted.” we shall talk about how the institutional traders managed their positions based on mispricing of options on the background.
The Vega expansion
Today’s rally was an intelligent move by the market maker. To understand this, we must look into what they did towards the beginning of the November expiry. The institutional traders had created spreads to neutralize the uneven Vega expansion in the options market towards the beginning of the November contract. The question is what caused this uneven expansion in the options Vega?
The Option Premium Impact
If you watch closely, Bank Nifty was bursting in confidence from 23rd November. After the surprise Gap Down on 17th Nov (It wasn't surprised as auction process indicated a gap down on 16th Nov) , sellers couldn’t even give 500 points futher selling .Again, ask why? Spreads were placed in such a way that call premiums were squeezed to a level of undervaluation with pouring a very calculative amount of points on put side (see what 42,000 PE Dec contract did on 21st and 22nd Nov when Bank Nifty made new low by 300 points). The calculative nature of that move caused the implied volatility in certain strikes in the November contract to rise. The institutional traders took advantage of the uneven expansion in options implied volatility and waited for the right time.
Blue circle are the institutional buyers 2 days in a row.
The Right Time!
Bank Nifty weekly had a total premium of 607 points on 21/11, which indicates that bank nifty can give a 600 points movement on either side. 44,169 was the trigger level for sellers as any minute close above that level could mean extension of the movement on that side. Cherry on the cake was a gap up today (29/11) with a presence of institutional buyers in the 3D Delta profile (Attached picture of today’s profile). Premium gave a target of 44,738 and coincidentally Bank Nifty future made a high of 44,722 and 3D delta gave a target at 44,751 which a is virgin VPOC of 12th Oct. What do you do when you have a brilliant concoction of 3D Delta + Premiums? You go for a Knockout!
Today morning, those spread which were initiated, were wrapped up after 20 days of trading. Positive news was splashed all over at the same time to make it look like a trigger. The unwinding of the spread triggered massive mispricing in some Call option strikes. One of the strikes was 44,400 Call option. A major advantage of capturing options mispricing is, it pinpoints the entry points at low risk zones. Take for example the 44,400 call option today. The institutions entered the call when it was at INR 30. This is an extremely smart move, as the net risk now is just INR 30. Based on the institutions; the 44,400 call was bought @ INR 34. Then Bank Nifty zoomed up and the call registered a high of INR 363. The position was squared off at INR 148 then INR 268 giving us a whopping 5x to 8x gain on buying options.