India’s Bank benchmark Bank Nifty Future registered a high of 48,915 today. Today was a good day to understand how ratio traders function. While most market participants were anticipating a buy breakout in last 3 trading session. The institutional traders took advantage of the situation and made a smart move. They forced the index to remain inside a range of 500 points after it touched 49,086 levels. The question is how did they do it?
The Institutional Spread
You’ll notice, Bank Nifty registered a negative opening today around 48,751. The index then registered a high of 48,915. Thereafter Bank Nifty slipped into a narrow curvature. The question you want to ask is, “Why Bank Nifty slipped into a range if the breakout is true”?. 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. Today was one such day.
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
3D Delta software has been on a dry run since last 3 days – what that means is no presence of any institutional buyer or seller. Why is that? It’s because they had initiated ratios right from Monday (8th April). On similar contrast, 48,600 pair was sold (Pair – Same strike call and put) with the appropriate hedges at a collective price of INR 612. Bank Nifty slipped 250 from there and closed almost near the lows. What one should note is, Calls lost 40% of its premium but put remained the same. WHY? The spread was covered towards the end of the day by eating up 125 points. This was a pure Intra-day spread.
