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 221 points move in Bank Nifty between 31444 and 31223, was in stark contrast from other days. Thus in today’s article we shall discuss about this strikingly different behaviour 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 31299, made a low of 31223 and then went on to make a high of 31444. Indeed it is not a big deal, given that the index had merely moved 221 points between the high and the low of the day. Thus a 221 points move is equivalent to a range bound day of trading.
If you watch closely, Bank Nifty futures opened around 31300 this morning. Around the same time, the underlying instrument opened 113 points higher, at 31413. 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 31349 and futures closed at 31317.These are the opportunities the market makers are intelligently exploiting at all times.
Now let us observe how the market makers made money from the backwardation scenario. Around 2:15 pm Bank Nifty futures made a high of 31444. Around the same time, Bank Nifty spot made a high of 31462. 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 options gamma and theta was a complete mismatch. We followed their footstep and tracked the 31400 Call option. The call option was sold around Rs.80. Although we covered the call at Rs.19 approx, it was later reduced to zero. 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 requires approximately Rs.30,000 per lot if the position is covered the same day.