Traders often claim that you can make a lot of money, if you buy options and track the news. In today’s article, we shall discuss one parameter which can help retail traders, trade the impact of news, without having any knowledge of the news. We shall also back it with today’s live trade. The function is called Implied Volatility. The important question is why implied volatility? Simply because, those who understand the role of implied volatility are champions in trading option.
The Importance Of IV Component
There are several factors that cause option premiums to change. Implied Volatility is the most important amongst them. If you look closely, you will notice, retail traders are mostly focused on news or events while trading, they hardly ever look into the IV. So how can they change this? We all know that there are different factors that are responsible for the movement in options premium. Most of them are successfully computed by experts. However, Implied Volatility is a component, which can be computed only if we know where the market maker is standing between 9:15 am and 3:30 pm. For this reason, IV plays the most crucial role in determining the price of an option.
Trade Execution With IV
For ease of understanding, let us consider today’s example. What we did was simple and can be replicated by retail clients also, once they have a grip on the IV factor. First we checked the position of the market maker in the morning and found that they were preparing to buy Nifty. Then we checked implied volatility of the option strikes the market maker was focusing on. We found that the IV of those strikes was reflecting unnatural change. This is where things got interesting; we evaluated the IV drift and found that the 12200 Call and 11850 Put in the weekly contract was a perfect match. We bought the call option at Rs.16 and the put option was bought at Rs.10 when the IV was conducive. So our total investment was Rs.26 (16+10). It is important to note that the market maker was also building long positions in Nifty at the same time. From there, Nifty rallied and broke the 12100 levels and made a high of 12154. If you look closely, you will notice, when the 12200 call made a high of 43 today, the 11850 Put remained pinned at 10.60 despite a 90 points upside move in Nifty future. Surprising isn’t it? This is the beauty of understanding implied volatility. We squared off the position when the sum total of the call and put was @ 46 thus generating a 76% return by buying option even on a day when India Vix was below 14 for the whole day.
Nifty 12200 Call Option Trade
Nifty 11850 Put Option Trade